Chainlink 101: The Crypto That Brings Real-World Data Into The Blockchain

Jonathan Hobbs

5 mins

Chainlink 101: The Crypto That Brings Real-World Data Into The Blockchain
  • Blockchain smart contracts often require data from outside the blockchain. And Chainlink’s network of oracles can provide it in a decentralized, reliable way.

  • Chainlink’s node operators handle the technical aspects of getting real-world data to the blockchain, with incentives to make sure it’s high-quality data.

  • To secure the blockchain, node operators put up LINK tokens as collateral. Smart contracts, meanwhile, pay for Chainlink data using LINK.

Blockchain smart contracts often require data from outside the blockchain. And Chainlink’s network of oracles can provide it in a decentralized, reliable way.

Chainlink’s node operators handle the technical aspects of getting real-world data to the blockchain, with incentives to make sure it’s high-quality data.

To secure the blockchain, node operators put up LINK tokens as collateral. Smart contracts, meanwhile, pay for Chainlink data using LINK.

Mentioned in story

If you’ve been following our Crypto 101 series, you understand how Ethereum smart contracts can process complex transactions on the blockchain without a middleman, such as a bank. Well, smart contracts need data from two sources: the blockchain (“on-chain”) and the real world (“off-chain”) – and Chainlink forms the bridge between two. So let’s learn more about it, and why you might want it on your crypto watchlist.

So, what’s the story behind Chainlink?

Its origin story is pretty simple: In 2017, entrepreneurs Sergey Nazarov and Steve Ellis, and Cornell Tech professor Ari Juels released the Chainlink white paper.

The paper solved a problem that many in the crypto community were grappling with: how could smart contracts get reliable data from the outside world?

Why do smart contracts need outside data?

Smart contracts, those programmable rules that developers can build on certain blockchains, are actually the backbone of thousands of decentralized applications (dapps) that run on them.

Suppose a sports betting dapp wants to use a smart contract to pay out its users based on the results of a soccer game. But there’s a problem: the outcome of the match isn’t stored on the blockchain.

To do its job, the smart contract needs data from the outside world. This can come from an “oracle,” which is a piece of software that links the blockchain to the internet. Here, the oracle uses an API (application programming interface) to retrieve online data (the results), and convert them into a code that the blockchain smart contract can read. This is similar to how the news app on your smartphone uses an API to fetch the latest articles from the web.

Conceptual diagram explaining how oracle’s link the blockchain with the internet.
Conceptual diagram explaining how oracle’s link the blockchain with the internet.

Of course, oracles are more reliable when they’re decentralized. This way, no single person or entity controls the data feed, and the smart contract knows the oracle is telling the truth.

So, how does Chainlink work then?

Chainlink is a decentralized network of oracles that connects data between the outside world (off-chain) and different blockchains (on-chain). It formats this data so that smart contracts can easily understand it, and uses blockchain technology to make sure its oracle information is accurate and reliable.

Each oracle is run by a node operator – a person or entity that handles all the technical aspects of getting real-world data to the blockchain. Chainlink’s own blockchain works to incentivize node operators to do what’s best for the network – i.e. provide the best quality data.

If a smart contract from another blockchain needs data, it puts in a “data request” to Chainlink. The Chainlink algorithm then does three things. First, it scans its oracle network and ignores node operators that are unreliable, or have questionable reputations. Second, it matches the data request with the remaining reliable node operators, who then go out and find the answer. Third, it analyzes all the answers from each oracle to get the most accurate response, which it then sends back to the smart contract that requested it.

Where do LINK tokens come in?

LINK is the currency that works to keep Chainlink truthful and secure. Here’s how it does this: Chainlink is a proof-of-stake (PoS) blockchain, which means there’s no mining or miners. Instead, node operators “stake” (i.e. deposit) LINK tokens as crypto collateral so Chainlink runs smoothly. In return, they can earn more LINK. Of course, there’s a catch: if the node operators are caught bending the truth, they can lose their entire stake.

Here’s another reason the token is important. If you want Chainlink data, you’ve got to pay for it with LINK. So as the Chainlink network grows, there’ll be more demand for the token (all else being equal).

So, how big is Chainlink’s network?

According to Chainlink’s latest report, the blockchain has data feeds with over 1,200 crypto projects across the DeFI, crypto gaming and NFT sectors. What’s even more interesting is that these projects are spread among most of the major smart contract blockchains – including Ethereum, Binance Smart Chain, Polygon, Solana, Fantom, Avalanche, Polkadot, and Cardano. So if you’re long-term bullish on the growth of the crypto ecosystem, it could make sense to own LINK.

Chainlink also connects to crypto exchanges like Binance, and price providers like Coinmarkecap to get pricing data to DeFi smart contracts. It’s also linked up with Google Cloud, Amazon Web Services, SWIFT, Oracle, and a range of other off-chain data providers. So, Chainlink really is the bridge between the blockchain and the off-chain world.

What are the risks?

As with any digital asset investment, Chainlink’s got its risks.

For one, LINK could get diluted in the future. The maximum supply is said to be 1 billion tokens. As of right now, only half of those are in circulation – as in: available for trading. If more of that supply is released to the market, it could suppress the token’s price.

For another, the top 1% of Chainlink addresses hold more than 90% of the total token supply, according to data from Glassnode. That’s not quite as high as, say, Ethereum with around 95% – but it’s been trending up steadily since 2017 when it was just 30%. When too much supply is held by just a few big investors, they can have an outsized influence on the price if they decide to offload their holdings.

And finally, there’s the risk of policy changes. For investors who believe in the future of decentralized finance (DeFi), LINK tokens are a no-brainer – because Chainlink is the gold standard for DeFI protocols needing quality price data. But DeFi could run into some major regulatory hurdles in the coming years, which could slow the sector's growth for a while.

Now test your knowledge with our Chainlink 101 quiz.

Chainlink 101 quiz.
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