Chainlink (LINK) Touches EVERYTHING in DeFi. How Does Chainlink 2.0 and Super-Linear Staking Affect Your Favorite Project?

By Michael @ CryptoEQ | CryptoEQ | 21 Jun 2022


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Chainlink is a framework for building Decentralized Oracle Networks (DONs) that connect smart contracts to other blockchains, off-chain data and computational capacity. The oracle node operators are designed to be sybil resistant and are modeled as economically rational agents; who are then incentivized to provide accurate data in order to protect staked funds. The node operators retrieve data from off-chain data providers before aggregating and delivering it on-chain. Serving this data on-chain allows other smart contracts to securely interact with it, hence why Chainlink has become the best adopted oracle on the market as DeFi has grown, feeding data into projects that collectively support ~$16 billion dollars in value.   

Chainlink’s  DONs are primarily built on Ethereum, and various other chains and L2s. 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.” In addition to being an important building block for DeFi, the LINK project could  help connect blockchains to the traditional world of finance. With use cases such as  payment gateways, financial agreements, insurance, among myriad others.

Chainlink 2.0

Chainlink published a new whitepaper in April of 2021 outlining ongoing design improvements for DONs, primarily aiming at ensuring network security as Chainlink scales and ensuring node operators continue to be adequately incentivized to support oracle services, among other objectives. While Chainlink 1.0 described DONs, Chainlink 2.0 describes DONs bidirectionally communicating with one another, and periodically syncing with blockchains to leverage their security, similarly to Level 2 solutions. The vision is that these networks of connected DONs will enable off-chain computational power and other scalability benefits.  In addition to the above, VRF and OCF (reducing the operating costs for nodes computing oracle outputs via taking computation off-chain), Chainlink has also rolled out ‘Keepers’, live on the Ethereum Mainnet since August 2021, aimed at supporting smart contract automation through secure ‘hybrid’ on/off-chain technology. Chainlink Keepers are off-chain, though still decentralized, and can manage computational activity off-chain and thereby mitigate chain bloat while saving on gas-fees. Keepers run computation off chain, check specified conditions are met and then trigger on-chain functions. Keepers can be interacted with by any LINK holder through the security operations platform OpenZeppelin Defender

 

Chainlink Strengths

  • Chainlink’s oracle network creates a trustless bridge between blockchains, such as Ethereum, and off-chain data sources, providing a viable solution to the Oracle Problem. 
  • A generalized approach to Oracles, seeking to reliably connect external (off-chain) data-feeds, APIs and data from other blockchains, represents a wide opportunity space for Chainlink to capitalize on.
  • Chainlink continues to innovate and remain competitive in a fast moving industry, as evidenced by the Chainlink 2.0 whitepaper released in 2021. In addition to refining their staking mechanism Chainlink has released a suite of new features, such as Verifiable Random Functions (VRFs), Off-chain Reporting (OCF) and Keepers and even a Cross-Chain Interoperability Protocol (CCIP). Successfully rolling out many major feature upgrades bodes well for Chainlink’s capacity to scale further. 
  • Chainlink is designed to be used with any blockchain and has networks running on various Ethereum L2s in addition to Binance and Avalanche (among others)
  • Chainlink was a first mover in the decentralized oracle network space and had promising traction with the world of Traditional Finance (TradFi) such as a proof-of-concept with SWIFT, before finding a viable market fit with the booming DeFi ecosystem. Chainlink also won partnerships with blockchains like Binance and Polkadot, and large corporate entities like Oracle.
  • As smart contracting technology penetrates legacy systems, Chainlink may benefit from increased adoption and the potential growth of the crypto industry as a whole.

Chainlink Weaknesses

 

  • Chainlink is crucially important for myriad DeFi applications, while Chainlink has thus far seemed to successfully protect projects from ‘Flash Loan’ attacks, and others made possible by centralized price oracles, it is possible new attack vectors could emerge that prove vulnerabilities in the Chainlink system. 
  • Chainlink’s oracle network is still quite limited (~332 nodes) relative to a blockchain like Ethereum (with 1,000’s of nodes) and could benefit from increased redundancy and security should it be further decentralized.
  • Since Chainlink is built on Ethereum, issues with Ethereum could also impact LINK.

 


Economics

 

In May 2019, Chainlink went live on the Ethereum blockchain and with it came its own ERC-677 utility token, LINK. An ERC-677 token is a token whose functionality is based on the ERC-20 token standard, but also has ‘transfer and call’ functionality.

ICO

In September 2017, Chainlink held its Initial Coin Offering (ICO) with a $32 million hard cap. The ICO originally offered LINK at $0.09 per coin with a 20% bonus, depending on how early the purchaser invested. The following public sale sold LINK at $0.11 per token. In all, both sales distributed 350 million LINK to the public while 1 billion LINK in total were created. 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

LINK ICO distribution Source​​​​​​

Since the ICO in 2017, Smart Contract Limited appears to have sold ~57 million tokens. The remaining tokens have no lock-up/vesting schedule and token selling from the Smart Contract Limited wallet has increased in 2021. 

LINK selling by team LINK selling by the team has increased recently as token price has increased. Source

Super-linear Staking

Super-linear Staking aims to ensure that the capital requirements for a successful network attacker would have to be quadratically larger than the combined deposits of all nodes. 

In April 2021, the Chainlink 2.0 whitepaper was released, introducing a new architecture for Decentralized Oracle Networks. Decentralized Oracle Networks functions similarly to Layer-2 solutions, significantly increasing the speed of data delivery and boosting security. Furthermore, Chainlink introduced its super-linear staking model, a crypto-economic security mechanism that incentivizes nodes to deliver accurate oracle reports and significantly increases the cost of attack for malicious actors. 

In April 2021, the Chainlink Foundation released the Chainlink 2.0 White Paper outlining the future of Chainlink. Authored by a world-class roster of academic researchers specializing in fields such as security, cryptography, distributed systems, game theory, mathematics, and computer science, Chainlink 2.0 enhances the cross-chain interoperating Decentralized Oracle Networks (DONs). Notably, Chainlink 2.0 introduces super-linear staking for $LINK which requires an attempted attacker to have greater resources than the combined security deposit of all DON nodes in order to succeed. The introduction of staking implements a new lever impacting the liquid supply of $LINK.

LINK staking roadmap june 2022 ​Source

Market Metrics

LINK's supply is fixed at 1 billion, there is no programmatic inflation within the LINK ecosystem. Node operators’ rewards (350 million LINK) have yet to be fully distributed, but remain liquid, as there are no restrictions or locked periods within the contract. The ongoing distribution to node operators and eventual selling from Smart Contract Ltd. could add noticeable selling pressure to the market. 

LINK’s circulating supply of ~467,000,000  suggests that some 110,000,000 million tokens have been distributed since the 350 million were distributed via ICO. 

Chainlink, balances, treasury Figure. LINK held by the Chainlink team shortly after ICO. 

Token Distribution

As of 2022, 47% of supply is circulating across 350k+ total wallets.  35% is controlled by node operator’s incentive fund, 25% is held by the team for development, and ~16% is held in exchanges.No wallet outside of teams, nodes, or exchanges holds over 1% of funds.

Wallets holding more than 1% of the total supply account for 66.6% of the supply. The distribution of those wallets follows:

  • Smart contract for Chainlink node operators: 35%
  • Chainlink team: 24.8% across five different wallets
  • Binance: 3.4%
  • Aave LendingPoolCore: 2.7%

LINK wealth distribtion June 2022 Source

Incentives and Fees

LINK works 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.

As of Q3 2020, nearly half of LINK fees go to paying ETH gas fees. If meaningful solutions to scaling are realized on either the Ethereum chain, which is currently under development or within Chainlink, as discussed in the Technology section, this could reduce the demand for LINK unless the network grows at a proportional rate. However, this argument is still but a thought experiment as it is too early in Ethereum’s scaling endeavors and LINK’s adoption cycle to make conclusive statements. 

When a user creates a smart contract, they set a price (in LINK) on how much they’re willing to pay for this particular data retrieval.  Nodes then bid on the request in LINK. As the node returns acceptable data to the smart contract, it will be paid for both partial and/or whole completion.

As the demand and value locked within smart contracts grow, oracle nodes will need to deposit greater and greater amounts of LINK collateral to ensure the security of the network. Because deposits are required to participate in the network, this creates demand for the LINK token, and ultimately, a supply sink for a fixed-cap token.

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.

There are two high-potential and obvious markets that Chainlink is pursuing since its 2019 launch on Ethereum’s mainnet: large financial institutions, and Fintech use cases. 

Large financial companies are exploring implementing smart contracts to remove inefficiencies and middlemen in their operations, as well as offer previously not possible services and products to generate new revenue streams. In October 2017, Chainlink completed a year-long proof of concept for smart contract-based Bond payments over the SWIFT network. SWIFT presents an opportunity for sizable market share penetration within the legacy system. SWIFT processes about 11–13 million securities messages per day, or ~3 billion per year. Capturing this particular use case alone would mean LINK would process >800,000 transactions per day; more than any other blockchain aside from Ethereum.  

However, like all crypto assets, a large portion of the network activity is derived from speculation. LINK, in a sense, can be viewed as a bet on the proliferation of smart contracts and a growing trend towards more decentralized solutions. This type of speculation can be healthy for a growing industry, as it adds awareness and extra capital to sustain itself. Initially, Chainlink subsidized the cost to nodes in order to bootstrap adoption, which appears to have helped propel it to one of the most critical crypto projects in the space. 

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Michael @ CryptoEQ
Michael @ CryptoEQ

I am a Co-Founder and Lead Analyst at CryptoEQ. Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.


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