I grew up watching Nollywood movies where chief priests, in response to seekers’ questions or concerns, tell them to hold on while they ask the Oracle for answers. From a child's mind (that’s me), an oracle meant the key to all, or at least, many answers.

Glad to inform you that it hasn’t changed, at least not in concept. Oracles still convey the same meaning even in the crypto space.

In the context of crypto, an "oracle" refers to a third-party platform, protocol, or mechanism that supplies external data or information to smart contracts and decentralized applications (dApps) with external information or data from the real world. The term originates from ancient Greek mythology, where oracles were revered as sources of wisdom, knowledge, and insights.

In addition to supplying smart contracts with information, oracles can send out information from blockchains to other systems.

Smart Contracts ↔️ Oracles ↔️ External Data

Why do smart contracts need oracles?

Smart contracts, pioneered by the Ethereum blockchain, are automated contracts that self-execute when pre-determined conditions (which have already been programmed) are met. Smart contracts only execute actions based on the data available on-chain limiting their functionalities. This is where Oracles come in. They serve as bridges between smart contracts and the outside world, fetching data.

Oracles retrieve data like crypto values, stock prices, number of votes, etc externally and feed the data to smart contracts. Without oracles, the data that smart contracts use will be limited to those available on the blockchain.

Classifications of Oracles

Oracles are classified according to their sources (one or more sources), their trust models (decentralized or centralized), or their types (software or hardware).

Centralized oracles: they are managed by single entities that are in charge of compiling off-chain data and updating the Oracle contract's records upon request. Because centralized oracles rely on a single source of truth, they are effective. However, there is always the possibility of price manipulation. To prevent this, decentralized oracles came into play.

Decentralized oracles: by removing single points of failure, decentralized oracles are intended to alleviate the drawbacks of centralized oracles. A decentralized oracle service is made up of several peer-to-peer network members who agree on off-chain data before transferring it to a smart contract. This means they are permissionless, trustless, and not controlled by central bodies.

Software oracles: are software services that verify external data after retrieving them, and then providing them to smart contracts on the blockchain.

Hardware oracles: are physical devices, like IoT devices that feed smart contracts with data from the external world.

Applications

DeFi: Oracles are useful in DeFi apps that need real-time price feeds to track asset value.

Insurance: Oracles can be used to obtain data that is useful for insurance products, such as airline delays and meteorological conditions.

Digital identity: To authenticate a user's identification data, such as documents and certificates, provided by an issuer, digital identity systems can make use of oracles.

Prediction Markets: oracles predict outcomes and identify winners in real-world events.

Supply chain: oracles can confirm data regarding the whereabouts of products throughout a supply chain.

To sum up, oracles are essential for expanding the capabilities of DApps and smart contracts since they let them access and work with real-world data.