Last week, the Chainlink team announced their latest client upgrade, Off-Chain Reporting (OCR) which provides efficiency improvements to how data is processed and moved across Chainlink oracles, resulting in a ~90% reduction in oracle operating cost. The Chainlink team states that with this upgrade DeFi users will have a 10x increase in the amount of data that can be put into their smart contracts, broadening the surface area of DeFi.
OCR accomplishes all of this by allowing nodes to now communicate off-chain, enabling them to aggregate data without the cost of gas. The new process for nods involves each node fetching data from multiple sources, signing it via their private key, and broadcasting it to the rest of the oracle network off-chain. Once enough of the oracle network has responded, only a single transaction containing all the node's attestation is processed on-chain. The signatures are then validated on-chain by a smart contract, providing the security, transparency, and tamper-resistant properties inherent from the main chain. This is exciting news and comes at a time when DeFi use cases are exploding. LINK was a stand-out crypto-asset in 2020 and it is encouraging to see the project continue to evolve and improve. Will 2021 be a repeat of 2020 for LINK? Who knows?! But aside from this latest news, it's important to understand the other fundamental drivers of the project as discussed below.
Chainlink is a decentralized oracle network built on Ethereum designed to connect off-chain data sources to on-chain smart contracts. LINK serves as the utility token for the Chainlink network which acts as a trust-minimized middleware solution to the “oracle problem” by providing “reliable tamper-proof inputs and outputs for complex smart contracts on any blockchain.” The LINK project aims to become the standard for interacting with other off-chain services, such as payment gateways for use cases including financial data, financial agreements, insurance, and others, linking the legacy world with the new world of blockchains.
- Clear utility, use case, and adoption - Chainlink presents a new solution to the “Oracle Problem,” creating a secure, private, and trustless bridge between blockchains and off-chain data feeds.
- First-mover advantage and tremendous network effects - Chainlink already has an established partnership with SWIFT, other blockchains (Binance, Celer, Polkadot, etc.), and a long list of partnerships.
- Expansive addressable market - Possibilities include finance, insurance, legal, gambling, payments, and anything else composed of off-chain data that may be incorporated onto a blockchain.
- Benefits from the growth of the crypto industry as a whole - As smart contracting technology penetrates legacy systems, Chainlink and LINK benefit from this adoption.
- 60% of the supply is currently not freely traded on the market and remains under the control of the parent company.
- There are no explicit guidelines or restrictions regarding the distribution of the supply reserved for the project’s development and oracle incentive.
- Oracle network is still limited (~185 oracles) but growing, further decentralization is warranted.
Chainlink is a decentralized oracle network built on Ethereum designed to connect off-chain data sources to on-chain smart contracts. “Oracles” can be thought of as the bridge on which on-chain smart contracts access, retrieve, and verify data originating outside of a blockchain. The challenge of getting off-chain information on-chain in a reliable, trust-minimized manner is generally known as the "oracle problem," and has remained largely unsolved since the creation of Bitcoin. Utilizing information sourced outside the native blockchain introduces new potential attack vectors -- i.e., how accurate is this data? If the data provided to the smart contract could ultimately be used to exploit the system for tens of millions of dollars, then an attacker has the incentive up to tens of millions of dollars to manipulate that data. Because of this, the oracle network must be designed to reduce the impact of a bad actor(s), reduce their incentive to provide inaccurate data, and minimize trust around one data point.
Chainlink puts forth its solution to the “oracle problem” by connecting different blockchains to the off-chain world while providing “reliable tamper-proof inputs and outputs for complex smart contracts on any blockchain.” As an oracle, the solution it offers is trustless connectivity to any API endpoint. In addition, the LINK project aims to become the standard for interacting with other off-chain services, such as payment gateways for use cases including financial data, financial agreements, insurance, and the like.
The primary use case is bringing trust-minimized and secure third-party data via its secure middleware solution without interfering with the blockchain’s consensus. Chainlink is a highly secure and highly flexible oracle network interfacing the legacy world and real-world data to blockchains.
Chainlink has created the vital middleware infrastructure to provide information to and from blockchains without sacrificing decentralization or security. The core technology of Chainlink depends on a two-part process – on-chain and off-chain. On-chain, Chainlink is simply a series of smart contracts that respond to requesting contracts demanding data. Off-chain, the Chainlink architecture is a network of oracle nodes that connect to public blockchains.
The Chainlink on-chain smart contracts are “externally aware,” meaning they carry a piece of data that helps them integrate with non-blockchain applications. This enables a decentralized oracle data feed that is aggregated into the smart contract off-chain and then converted into on-chain data.
For operations off-chain, Chainlink consists of a network of nodes connected to the Ethereum network. These nodes listen independently for off-chain requests. Eventually, individual responses to smart contract queries are aggregated and returned to a requesting contract.
The oracle network contains a collection of nodes with specific job specifications, who can carry out particular job executions coordinated by on-chain smart contracts. Nodes operate independently of each other and cannot communicate with one another. Instead, nodes communicate with the blockchain node to which they are “attached” and listen for job requests. Each node sells the use of specific data feeds, off-chain payments, and APIs directly to the smart contract.
Chainlink has certain checkpoints in place for preventing inaccurate data and reducing vulnerabilities or manipulation. To safeguard against single points of failures, data sent through the network is curated and verified through a decentralized majority voting system of Sybil-resistant nodes. Chainlink, also, utilizes a reputation and certification system for oracle performance. The reputation contract within Chainlink keeps track of oracle-service-provider performance metrics.
In September 2017, Chainlink held its Initial Coin Offering (ICO) with a $32 million hard cap. The token distribution was as follows:
- 35% allocated to the token sales investors
- 35% reserved for node operators and ecosystem rewards to incentivize network participants
- 30% allocated to SmartContract.com, Chainlink’s parent company
In May 2019, Chainlink went live on the Ethereum blockchain and with it came its own ERC-677 utility token, LINK. LINK's supply is fixed at 1 billion and all the tokens have technically been distributed, meaning there is no programmatic inflation within the LINK ecosystem. Node operators’ rewards (350 million LINK) have yet to be fully distributed and remain liquid, as there are no restrictions or locked periods within the contract. Therefore, as nearly 60% of the supply is still not freely traded on the market, the eventual release/distribution to node operators and eventual selling from Smart Contract Ltd. could serve as a form of inflation while also adding noticeable selling pressure to the market.
Figure. LINK selling by the team has increased recently as token price has increased.
LINK works as a financial incentive to align incentives, promote cooperation, and reward accurate data providers for the good of the network. LINK is used to compensate data providers and serves as collateral within the system where node operators stake LINK deposits when providing data (giving them “skin in the game”). Nodes get rewarded to retrieve and provide data, and the reward amounts are determined by the contract creator.
Currently, Chainlink’s value is strongly connected to Ethereum’s growing DeFi scene, but this does not have to be the case indefinitely. It is only because the crypto smart contract industry is so young (<5 years) that Ethereum represents the vast majority of current use cases. Because Chainlink is blockchain agnostic and compatible with other chains, its market cap can scale with the entirety of smart contracting platforms, beyond any isolated chain, into Web 3.0, DeFi, and other applications not yet in existence.
LINK is a utility token for middleware infrastructure and also has a parent company, SmartContract.com. SmartContract was funded by Data Collective DCVC in an initial seed round in 2014.
Behind the scenes, Chainlink is run and governed by the LINK team consisting of a CEO (Sergey Nazarov), CTO (Steve Ellis), team of engineers and business development personnel, and board of advisors. Unfortunately, most decisions are made unilaterally by the team and serves as a large centralization risk. On-chain, there is no formal governance structure, as LINK operates atop the Ethereum blockchain and off-chain decisions are left to the team. The community has no real power on how the Chainlink team chooses to use their ICO funds.
LINK tokens help create self-regulating governance (of sorts) of the Chainlink network by creating economic incentives for honest behavior.
Development of Chainlink is open source, allowing anyone to review and contribute to the code. The project has dozens of repositories on Github with the most active repo accruing over 4,000 commits from 33 developers over the past year. The current codebase is still under active development as is evident by ranking #2 in activity over the last year within the crypto space.
As of Q1 2021, LINK has 185 price oracles for the Ethereum network, which are used as an aggregate pricing network for DeFi applications. Most of these oracles are currently approved by the Chainlink team, as the true decentralized vision of the project has yet to be realized. 180 oracles (or nodes) is more than in the Delegated Proof of stake system of EOS (21), but far less than in a truly decentralized, permissionless system like Ethereum (~7,200) or Bitcoin (~10,200).
Security in the Chainlink system is ultimately controlled by economic incentives and staking. LINK is subject to some inherited risk as it runs atop Ethereum, so any bugs or issues with Ethereum cascade down to LINK. That said, Chainlink has not suffered any public bugs and actively runs a bug bounty program.
Staking, collateral ratios, and a healthy oracle competition are incredibly important to Chainlink because if any aspect is “gamed” or becomes corrupted, the financial incentives protecting the network can quickly switch in favor of an attacker. What is most critical in the process is the value of the collateral being staked must be greater than or equal to the value of the assets being transferred in these contracts. As the crypto industry grows and smart contracts become more sophisticated, the amount of money to be made by corrupting the input data grows as well.
Further decentralizing the oracle network remains another area of improvement the Chainlink team acknowledges and is committed to improving. Clients using the Chainlink client smart contract can deploy Job specifications resulting in Job IDs being shared with other clients. This means every data request has a predetermined oracle that can fulfill the query. This is a downside of an early oracle network: randomness and pure competition amongst oracles do not currently exist.
The Chainlink network currently supports Ethereum, Bitcoin, Binance, and Hyperledger with over 200+ integrations in the pipeline, including 50+ additional blockchains. Some other blockchain projects intending to use Chainlink include Celer, Polkadot, Synthetix, Olympus Labs, Wanchain, Kaleido (ConsenSys), bZx, and ZeppelinOS. Chainlink is also crucial to DeFi projects like Kyber Network, AVA, Graph Protocol, Synthetix, and bZx as they rely on Chainlink’s oracles for ETH price feeds.
Partnerships have been a tremendous catalyst for LINK in the past, most notably Google, Intel, and Oracle. Chainlink’s real use case is demonstrated by its long list of partners, as well as SWIFT and Google from the traditional business world. Parent company Smart Contract Limited partnered with SWIFT after completing a proof of concept trial in June 2017.
LINK’s impressive integration and partnerships have driven on-chain activity of the LINK token to new highs, as seen below in the active address count of wallets each day that hold more than 10 LINK tokens. In 2019, wallets holding more than 10 LINK hovered around 10,000 addresses, but in 2020, that number has more than tripled to 35,000 active addresses.
Figure 5 LINK wallets holding > 10 LINK.
Finally, LINK has one of the most dedicated and vocal communities in the crypto industry, going by the name “LINK Marines”, a jab at the once equally relentless XRP community that refers to itself as the “XRP Army.” The main LINK Twitter page boasts ~70,000 followers, while the subReddit contains nearly ~20,000 subscribers. While these numbers and others, like Google Trends (below), are modest compared to the likes of Bitcoin, Ethereum, and XRP, the amount of press and visibility of the Chainlink project generated by the community stands toe to toe with any other project.