‘Pure’ DeFi has little chance for real-world use because of need for oracles: BIS

The need for an oracle in decentralized finance (DeFi) is a major impediment to adoption in the real world, according to the authors of a Bank for International Settlements (BIS) bulletin. The problems with oracles are both practical and principled, and the study’s authors saw no way around them.

An oracle is a third party that provides real-world data flowing to or from a DeFi protocol. An oracle is centralized by nature, and its presence means a protocol is not fully decentralized—if that is tolerated, then trustlessness is lost, the authors said. That is likely to be a fatal flaw for use with real-world assets, the authors wrote.

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Decentralizing an oracle could involve verification, a reputational system and multiple sources, the writers speculated. That would add layers of complexity and diminish the efficiency of the system. Issues of trust and governance would remain.

The anonymous nature of DeFi makes it hard to identify bad actors in cases of oracle manipulation, and:

“The obvious solution of increased regulation and supervision runs counter to the decentralisation ethos underpinning crypto DeFi.”

That regulation is not currently in place in any case, the authors noted. The irreversibility of transactions in DeFi also increases the amount of risk in the system.

Related: Seda co-founders discuss intersection of oracles and multichain

Trust issues are not a matter of principle for oracles. Oracle manipulation hacks occur on a regular basis. It was seen as recently as August in the Magnate Finance rug pull.

Crypto based #DeFi relies on oracles to import real-world data into their blockchain applications, but these centralised third parties introduce risks and inefficiencies. Can we overcome these problems? #Decentralisation #Blockchain https://t.co/DjGqTNX4kK pic.twitter.com/OVz57fGtkm

— Bank for International Settlements (@BIS_org) September 7, 2023

One solution to the oracle problem is to create a “centralised system whose bedrock is trust,” the authors said, but “when this trade-off is understood, the future of DeFi in its purest sense looks bleak.”

The study noted that companies such as Chainlink provide information to DeFi protocols. Chainlink claims to have developed “a network of decentralized oracle networks” with security measures tailored to each use case. Its Cross-Chain Interoperability Protocol uses the Swift network’s centralized messaging infrastructureto connect with clients, however.

Magazine: Can blockchain solve its oracle problem?