What is Chainlink? An Introduction to LINK & DeFi

What problem does Chainlink solve?

To understand what Chainlink is, you have to have some background on oracles. And to understand the importance of oracles, you have to know a bit about smart contracts. 

Smart contracts stand to save a huge amount of resources by automating many legal functions. For example, a smart contract might read “If Alice sends $10,000 to Bob, then transfer the title of Bob’s car to Alice.” This means you no longer have to go to the licensing office, pay a fee to the people who maintain the ownership records, get documents notarized, and so on and so forth. 

This is pretty simple, because a contract on the Ethereum blockchain, for example, knows when ether (ETH) is sent to it. But what happens when a smart contract needs more information? For example, what if someone wants to have a decentralized betting pool on who will win the World Cup? 

The whole point of decentralized applications is that they enhance security and reduce costs by removing the need for a trusted third party to secure and verify data. So if a smart contract needs some outside information, it needs a trusted, decentralized source to get that information. That’s what oracles are supposed to provide. 

When a smart contract is drafted, the contract is programmed to watch for signals from a trusted oracle. When it receives the signal it is waiting for, it executes the contract accordingly.

What is Chainlink and how does it work?

There are a number of projects racing to become the oracle of choice for the budding DeFi (decentralized finance) ecosystem. Chainlink is currently leading the pack. 

Chainlink may seem complex at first glance, but in reality it’s quite simple. There are two main parties— purchasers and data providers. Data providers “stake” link tokens and provide data about events. If they provide bad data, they lose their tokens, and if they provide accurate data, they are rewarded with more tokens. 

Signals are sent to contracts based on the data from multiple, trusted nodes. The assumption here is that since there is a strong incentive to provide accurate information, it is highly unlikely that all of the data providers will ever provide bad information. 

The purchasers pay for the data with LINK tokens, and the data providers collect their profits in LINK tokens, which theoretically will drive the value of LINK. 

The Case for Chainlink

A series of big partnership announcements helped fuel the hype around Chainlink, including a partnership with Google Cloud’s BigQuery. Other major partners include China’s national blockchain network, Intel, and T-Systems, the German national telecomm company. 

The aim of these partnerships is to integrate data from legacy financial and communications networks, and enable smart contracts to interface with it. 

Chainlink is also touted as being “blockchain agnostic,” which means it can be integrated with a number of different blockchains and smart contract platforms. This means it could “link” various blockchains together— for example, imagine the title to your car is stored on the Ethereum blockchain. You could sell your car for bitcoin, and the Chainlink network could verify that the transaction is confirmed, and send a signal to the Ethereum network to transfer the ownership of the car to the buyer.

Supposing DeFi does to traditional finance what Amazon is doing to retail, Chainlink could become a pillar of the budding industry, driving LINK into the stratosphere. 

Criticisms of Chainlink

Chainlink’s future is very much tied to the broader future of the cryptocurrency ecosystem, which is by no means assured. Chainlink operates on the Ethereum blockchain, which has had difficulty scaling up to higher volume in the past. There are proposed fixes to these problems in the works, but the development schedule has been delayed several times. 

Some analytics firms have issued reports that Chainlink trading patterns show signs of a pump-and-dump scam, or at least manipulation. Of course, pump and dump schemes can be orchestrated by outside players as well, so this doesn’t mean that the Chainlink team is implicated in the manipulation— by all accounts, they are working hard and have a functional product. 

Most of the criticisms surrounding Chainlink are not specific to Chainlink itself, but rather the viability of the broader DeFi ecosystem. What DeFi in general has going for it is the fact that it could result in massive savings by automating all kinds of annoying bureaucratic tasks, increasing both government and corporate efficiency and cost effectiveness.

On the other hand, price volatility, the possibility of legal loopholes turning into hacks that cost millions, and competition from centralized competitors all hang heavy on DeFi aspirations. DeFi proponents would point to projects like Maker’s DAI as a solution to volatility, but this still requires more intermediate infrastructure. When it comes to hacks or exploitation of smart contracts, they might argue that having plane crashes was an unfortunate but necessary part of developing modern planes. But that means there is a long way to go before these products have mass market viability, and with the pace of technological innovation, a lot could change before we get there.

Ultimately, a digital asset like bitcoin must be trustless, because its main selling point is that it is immune to inflation. Even if a government issued a digital currency and promised not to devalue it by means of inflation, would anyone really trust them to keep their word?

And while public trust in bankers may also not be that high, many people may still be willing to trust corporations with government oversight and a reputation to maintain rather than put their savings in the wild west of DeFi. 

Many are comparing the meteoric rise of LINK and the hype surrounding DeFi to the crypto rally of 2017, where hype drove Ethereum to nearly take over the crypto market. It was believed that decentralized apps (dapps) would cut out middle men like Uber and AirBnB, allowing the formation of giant person to person marketplaces. 

Three and a half years later, dapps are still largely unused due to poor user experience and slow speeds. Of course, proponents argue these are just growing pains. 

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Conclusion: If DeFi takes off, Chainlink will probably take off with it.

Trusted, decentralized oracles are an absolutely essential piece of infrastructure for visions of a future of decentralized finance. If these visions become a reality, or even if DeFi captures a significant percentage of the global financial market, Chainlink could be looking at a massive future valuation. The question is how realistic the DeFi visions are to begin with. 

Decentralized finance is great for people wanting to avoid government regulation as well as those wishing to minimize bureaucracy, and this ensures that there will be some demand for DeFi— it’s just not clear how much. Centralized finance, just like centralized apps, is likely to continue to outperform its decentralized counterparts in the near term, so the market for DeFi (and thus Chainlink) remains highly speculative.