This document provides a consolidated summary of my detailed research into Chainlink.
- Chainlink’s Role in Blockchain Evolution: Highlighting how ChainLink enables secure, real-time data processing and bridges the gap between various blockchains and external data sources.
- Enhancing Interoperability and Efficiency: Chainlink’s Cross Chain Interoperability Protocol (CCIP) is pivotal in connecting different blockchain networks, leading to a more integrated and efficient blockchain ecosystem.
- $LINK’s Unique Value Proposition: The multifunctional $LINK token is central to Chainlink’s network, enabling diverse and secure services by validators and promoting operational efficiency within the ecosystem.
The Blockchain Data Dilemma
Blockchains are designed to handle transactions within their specific ecosystems, ensuring high security and transactional efficiency. Yet, this design isolates them; they cannot process data from outside their systems or communicate with other blockchains, creating fragmentation. Oracle networks, like Chainlink, are the solution — they bridge these gaps by linking external data to blockchains.
Without oracles, blockchains are limited to four functions:
- Mint tokens
- Transfer tokens
- Swap tokens
- Dao voting via private keys
Undoubtedly, these are potent operations in and of themselves, but the vision for blockchain is much grander.
Oracle networks, existing beyond blockchain, enable trust-minimized computation with real-world data. This allows blockchains to interact with the outside universe. Oracles have catalyzed the creation of diverse applications, from lending platforms to insurance protocols — expanding functionality and interoperability. For example, if you want to borrow stablecoins on Aave, you need oracles. Lending applications require price-feed data outside the blockchain to stay solvent. Here is a simple breakdown of a lending app utilizing Oracles:
- A user deposits $100 worth of ETH as collateral to borrow against
- The user borrows $90 worth of USDT against their ETH collateral
- In the background, a Chainlink oracle continuously tracks the ETH/USD price feed from Coinbase and Binance, crucial for tracking the borrower’s loan-to-value ratio.
- The price of ETH drops 10%, decreasing the borrower’s collateral to $90
- Upon detecting this decrease, the oracle triggers a liquidation, resulting in the seizure of the user’s ETH collateral.
Without the oracle constantly checking the price of ETH, the lending protocol would incur bad debt, thus rendering lending applications useless. Oracles act as critical links between real-world data and blockchain ecosystems. However, this framework extends beyond just price feeds, encompassing the transmission of identity data, real-world assets, weather information, and more onto the blockchain.
Back when smart contracts were only a concept, Sergey Nazarov, founder of Chainlink, envisioned a world where blockchains would need to communicate with real world data. Now, ChainLink is doing just that.
With the launch of Chainlink’s Cross Chain Interoperability Protocol (CCIP), blockchains can now securely connect with each other. CCIP uses oracle networks to validate and process communication across different private and public blockchains. This communication includes:
- The movement of value
- The movement of messages (data)
Oracles enable the transfer of value and messages together. For instance, a transaction signer can now send tokens to a different blockchain with specific instructions, like “Send these tokens, exchange them for another type, and return them to me.” A user can conduct a token transfer to specify not just the destination blockchain but also the target smart contract. Thus, such capabilities empower any financial infrastructure to operate on a unified liquidity layer.
The global financial architecture is archaic and deeply integrated. Replacing it will be a long-term project. Imagine trying to change a jet engine mid-flight – it’s in use and highly complex. But what if technology evolved to seamlessly integrate with the existing financial framework? It would function as new type of fuel that can power both conventional airplanes and futuristic spacecraft without any modifications needed. CCIP is the universally compatible energy source. It facilitates the communication between the current system and blockchains – reducing friction for banks managing trillions of dollars.
Banks integrated with CCIP can define blockchain actions through existing APIs, such as SWIFT messaging. Let’s consider an example. Say you want to tokenize a gold coin and put it on-chain. Without Chainlink, that gold coin would have to be manually checked to be in custody, ensuring the backing of the token. In the past, asset managers were reluctant to invest billions in manually verified tokens due to the required trust in the verifier. But by using a ChainLink oracle network, that gold coin can be verified in custody every second. This constant verification boosts investor confidence in the authenticity of tokenized gold.
Extending the example, let’s say the end user wishes to liquidate their tokenized gold coin from their brokerage account. Under the hood, the brokerage uses CCIP to message a DEX on a specified blockchain for the sale of the tokenized gold coin and to verify the purchaser’s identity in compliance with regulations. By pulling accurate data from various sources into blockchains, CCIP enhances the credibility and feasibility of asset tokenization.
The opacity of mortgage-backed securities (MBSs) was a primary driver of the 2008 financial crisis. MBSs marked the first phase of mass securitization. The crisis stemmed from these financial instruments combining failing mortgages with solvent ones, leading investors to mistakenly believe they were purchasing entirely solvent debt securities. This represented a complete disconnect from reality.
Now, imagine if you had a smart contract that represented each individual mortgage. Every time the mortgage owner misses a payment, experiences a credit score decrease, or takes out another mortgage, the smart contract would update automatically. Such transparency in 2007 could have potentially averted the crisis by eliminating the opaqueness surrounding fundamental risks.
Securitization inherently increases risk in financial markets due to the obscurity of underlying risks. For instance, an original asset purchaser may be aware of the security’s risks. However, as the asset passes through hands — from the original purchaser to an investment bank, and then to an asset manager — crucial data can be lost. Now, with blockchain technology, oracle networks, and CCIP, we dispel the securitization smoke screen, maintaining transparency even as assets change hands.
For a protocol to thrive, it must function akin to a business, which typically comprises two key market players: a buyer and a seller. For instance, Bitcoin has miners and users, AMMs have liquidity providers and traders, oracles have operators and applications. Each contains a value proposition that lubricates both sides. For Chainlink, the $LINK token incentivizes node operators to maintain data integrity, while also encouraging fee-paying users to adopt a dependable data source.
The $LINK token incorporates design elements from both Ethereum and Bitcoin. The token has two functions:
- As a payment token, applications use $LINK to compensate validators for securing and providing data, establishing $LINK as the native currency of the Chainlink ecosystem.
- For securing a group of nodes, similar to Ethereum, node operators stake their $LINK to demonstrate their commitment to security. Additionally, each assignment requires a certain amount of $LINK, allowing service providers with more $LINK to undertake more jobs and generate greater revenue.
These distinct token use cases bolster network security and growth. Validators, compensated in $LINK, have an incentive to hold their tokens since staking more $LINK enables them to handle more jobs. The flywheel, driving this economic model, operates as follows:
- Service providers create the most efficient validator set possible
- Applications pay $LINK to the service providers
- Service providers stake earned $LINK to make the validator set increasingly robust
- New applications utilize the service
Applications utilizing Chainlink services pay $LINK to validators. For example, the infamous perpetual futures trading platform, GMX, is paying for Chainlink’s low-latency product to offer traders optimal price feeds. In return, GMX agrees to pay 1.2% of all fees generated by the platform [source].
How, then, is the price of Chainlink node operation determined? The long-term goal is for node operators to set their own prices, competing in an open market. However, node operators will compete on more than price – factors like longevity, security track records, and the amount of $LINK staked also play a role. Ideally, a market will emerge where node operators showcase their range of services, from price feed data to identity verification and Cross Chain Bridging capabilities. Applications with specific budgets can then select services that best meet their requirements. Different node service offerings for different applications.
A major value proposition of Chainlink lies in its interoperability among validators. While other oracles compete in specific areas (such as bridging or proof of reserves), none offer the comprehensive suite of services that Chainlink does. For instance, LayerZero provides a single service – bridging. So, if an application requires two services: bridging and price feeds, without ChainLink, they require two separate dependencies: LayerZero and a price feed oracle. The problem is, the more dependencies an application has, the less secure it is. ChainLink offers a dual advantage: validators can provide multiple services simultaneously, which reduces service fragmentation for applications and increases validator revenue through diverse income streams.
Another unique aspect of $LINK is its role in facilitating indirect investment into private blockchain activities. For public blockchains, investors purchase the native gas token as a bet that that blockchain will be successful; but, that’s not possible for private blockchains. But because CCIP provides a two-way street of data between private and public blockchains, $LINK benefits as the ‘toll token.’ Thus, buying $LINK is the only way to indirectly invest in the usage of private blockchains.
In the past six months of crypto there’s been significant discussion of real world assets (RWAs). Stablecoins (which are tokenized dollars) prove to be the killer application in crypto. Tether’s success is a testament to this. It is pertinent for the crypto industry to continue scaling along the vertical of its killer app. Even Larry Fink (the CEO of Blackrock) acknowledges this potential, stating that the next generation for markets is tokenization [Source]. This leads to a crucial question – which assets will the industry tokenize next?
When estimating the value of tokenized RWAs, many simply look at the current market of liquid real-world assets, such as treasuries, and apply this as the total addressable market. However, what’s often overlooked is that the process of tokenization itself is likely to generate entirely new categories of assets.
Fundamentally, blockchains function as financial systems with existing asset ledgers. The critical step now is to bridge the real world with these blockchain systems, paving the way for greater asset accessibility, faster transactions, and more cost-effective operations.
Written by: Qorban Ferrell
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