Blockchains are isolated networks which can only make use of the data available on-chain, similarly to how computers without internet connections can only make use of the data stored on the local device. While blockchains can ensure that records which are shared on-chain are kept and maintained, they cannot access or guarantee the integrity of data which originates off-chain, like the live price data for various assets, without relying on an external entity to provide that data.
The oracle problem refers to blockchains' inability to obtain data from or transmit data to external systems without relying on a separate entity. In an industry built around trustless systems, the oracle problem is the most difficult problem to solve in web3.
What is an Oracle?
An oracle is a critical piece of web3 infrastructure which allows information to be transmitted between the real world and blockchains. While oracles are mostly used to provide protocols with price data for various assets, they can also be used to provide any form of real world information including but not limited to medical information, weather data, or the live scores of sporting events.
Why are Oracles Important?
Oracles are needed to enable the most valuable use cases for web3 which involve complementing and improving existing systems like finance, social systems, and the overall data economy. The large majority of use cases provided by DeFi applications, for example, rely on oracles to report accurate price data which enables users to trade, lend, and borrow digital assets in a permissionless manner.
As a critical piece of web3 infrastructure oracles need to operate accurately, reliably, and securely at all times in order to guarantee all of the protocols which rely on their data can function as expected. Since oracles require some level of trust between the network participants who submit and verify the data and the protocols which rely on the data’s constant availability and accuracy, they are an incredibly fragile part of the web3 ecosystem. Many of the largest exploits seen in DeFi have been a direct result of oracle failures or manipulation.