Home Cryptocurrency What is Chainlink (LINK) And How Does it Work?
Asad Gilani Crypto Editor Author expertise
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Chainlink is a decentralized oracle network that bridges blockchain-based smart contracts and real-world data, APIs, and payment systems. It was created to solve a fundamental challenge in the blockchain space: the inability of smart contracts to interact with external data or execute actions in the real world.

Chainlink provides a secure, tamper-proof, and reliable way to bring off-chain data and events onto the blockchain. The strength of the Chainlink Network lies in its vibrant open-source community, consisting of data providers, node operators, smart contract developers, researchers, security auditors, and more. 

The company’s primary focus is to ensure that decentralized participation remains accessible to all individuals interested in contributing to the network, including node operators and users.

In 2017, Sergey Nazarov, Steve Ellis, and Cornell University professor Ari Juels jointly authored a white paper introducing the Chainlink protocol and network. 

This marked the inception of Chainlink, which was established as a critical link between blockchain systems and external off-chain environments. The network, designed to support smart contracts, was officially launched in 2019.

During 2018, Chainlink made an important integration by incorporating Town Crier, a blockchain oracle system based on trusted execution environments, which was also a project Ari Juels had been involved with. Town Crier facilitates the connection between the Ethereum blockchain and external web sources that use HTTPS for secure data retrieval.

Chainlink’s trademark was officially registered in the Cayman Islands on March 12, 2019, under the entity known as Smart contract Chainlink Sezc, Ltd. In 2020, Chainlink incorporated DECO, a project from Cornell University and co-developed by Ari Juels. 

DECO is characterized as a protocol that leverages zero-knowledge proofs to enable users to verify the accuracy of information to a blockchain oracle without exposing sensitive data, such as birth dates.

In April 2021, Chainlink released a second white paper titled “Chainlink 2.0: Next Steps in the Evolution of Decentralized Oracle Networks.” This document outlined their vision for expanding the capabilities of decentralized Oracle networks, including incorporating hybrid smart contracts that combine on-chain code with off-chain services provided by Oracle networks.

Chainlink conducted an Initial Coin Offering (ICO) in September 2017, generating $32 million in funds, and they had 1 billion LINK tokens in circulation. 

After the ICO, 35% of the LINK tokens were allocated to node operators to kickstart the incentivization of the decentralized Oracle network. Conversely, 30% remained with the Chainlink team to support ongoing development efforts.

To enable communication between the blockchain-based smart contracts it supports and external data sources, Chainlink employs a unique three-step procedure. The process begins with Oracle Selection, where a Chainlink user creates a Service Level Agreement (SLA) outlining their specific data needs. 

The Chainlink software utilizes this SLA to identify the most suitable oracles capable of supplying the required data. After configuring the parameters, the user submits the SLA and places their Chainlink (LINK) cryptocurrency as a deposit into an Order-Matching contract, which then receives bids from oracles.

Data Reporting is the phase in which the oracles establish connections with external data sources to retrieve the real-world data required by the Chainlink Service Level Agreement (SLA). Subsequently, these oracles process the data and transmit it back to the contracts that use the Chainlink service. 

Result Aggregation marks the concluding phase in this process, where the data gathered by the oracles is consolidated and provided to an entity referred to as an “Aggregation contract.” 

This Aggregation contract takes the individual data points, evaluates their credibility, and furnishes a weighted score to the user (smart contract) by combining all the received data. Its ability to authenticate data from various sources significantly strengthens this process. Chainlink achieves this by utilizing an internal reputation system, which allows it to ascertain the reliability of different sources reasonably. 

This, in turn, substantially enhances result accuracy and serves as a safeguard for smart contracts, shielding them from potential malicious attacks.

What role does LINK play in this process? LINK is used to compensate Chainlink node operators by the smart contracts that request data. The payment is made in LINK tokens and is determined by node operators, who set prices based on market conditions and data demand.

Additionally, node operators stake LINK tokens to demonstrate their long-term commitment to the project. Like a Proof of Stake (PoS) consensus mechanism, Chainlink operators are motivated by LINK rewards to incentivize them to act trustworthy rather than engage in malicious activities.

Chainlink is the result of a technology startup named SmartContract, which focuses on blockchain. Established in 2014, Chainlink aims to leverage blockchain technology, particularly smart contracts, to create contract agreements that are accessible to all industry participants, regardless of their level of skill and expertise.

Supported by the investment group Data Collective based in San Francisco, SmartContract embarked on turning this vision into reality by assembling a team of leading innovators.

Sergey Nazarov serves as the CEO and co-founder of the company. Before his involvement with SmartContract and Chainlink, Sergey had prior experience in the field, having founded Secure Asset Exchange, a cryptocurrency exchange. He also created a fully decentralized email service known as CryptoMail.

Steve Ellis, on the other hand, is the CTO and co-founder of the company. Ellis had previously collaborated with Nazarov on the Secure Asset Exchange platform before becoming part of this new venture.

He also boasts a background as a seasoned software engineer, with previous experience at Pivotal Labs before he transitioned into the blockchain industry.

Ari Juels is another pivotal member of the Chainlink team, and he, along with Nazarov and Ellis, authored Chainlink’s whitepaper. Juels, a computer science professor at Cornell Tech who serves as the director of IC3, is currently an advisor to the Chainlink team.

The Chainlink project boasts several unique characteristics, one of the most intriguing being its off-chain architecture. In this setup, the ChainLink network serves as a connecting element for all nodes. 

Each node is then linked to reserves through APIs to obtain responses for contracts that use the Chainlink service. Chainlink nodes can enhance their connectivity by incorporating external adaptors, which enable them to establish links with a wide array of third-party API endpoints.

The ChainLink Core software plays a pivotal role in translating off-chain data to make it easily readable on-chain without requiring additional translation. This software also handles the Service Level Agreements (SLAs) sub-tasks, meaning the entire process can occur either on-chain or off-chain. The crucial role of the external adaptors lies in enabling this architectural flexibility.

These external adaptors facilitate interactions with third-party API endpoints, bridging the gap between blockchain technology and real-world applications. It’s worth noting that all adaptors are coded in Chainlink’s schema to ensure seamless interoperability.

The Chainlink token (LINK) stands at the forefront of the rapidly evolving world of blockchain technology. Launched in 2017 by Sergey Nazarov and Steve Ellis, Chainlink’s mission is to connect smart contracts with real-world data, making it a vital player in decentralized finance (DeFi).

At its core, LINK serves as the fuel for the Chainlink network. It incentivizes node operators to provide accurate data to smart contracts by allowing them to stake LINK as collateral.

This unique mechanism ensures data integrity and reliability, which is critical for applications such as insurance, supply chain management, and decentralized oracles.

What sets LINK apart is its versatility. Beyond its utility within the Chainlink ecosystem, LINK has gained widespread adoption across various blockchain platforms and DeFi projects.

Its integration with Ethereum, for instance, has enabled decentralized applications (DApps) to access external data seamlessly, enhancing their functionality and potential use cases.

Investors and enthusiasts alike have recognized LINK’s potential, and it has become a popular choice in cryptocurrency portfolios. Its consistent presence in the top market capitalization ranks reflects its significance in blockchain.

The LINK staking mechanism aims to introduce a system of rewards and penalties to encourage the proper functioning of the Chainlink oracle network. It also aims to enhance the opportunities for node operators to receive tasks and earn fees within the Chainlink network.

In this setup, participants will lock up their LINK tokens as collateral, which can be subject to taxation or “slashing” in cases where a node provides incorrect data. The LINK tokens collected from dishonest validators through taxation will be distributed as earnings to honest validators.

The developers of Chainlink anticipate that introducing crypto-economic security measures will deter potential attackers by making the cost of attacking the network’s price oracle exceed the potential profits from such an attack. This strategy resembles other blockchain networks like Bitcoin and Ethereum’s gamification tactics.

Likewise, individuals holding LINK tokens who do not operate their nodes can engage in staking by delegating their tokens to a trusted node operator.

The Chainlink developers anticipate that the staking program will initially yield a 5% return, derived from a combination of emissions from the Treasury and fees paid by users of Chainlink’s data feeds. In the long run, the program will rely solely on fees earned by the network.

The involvement of community members in staking will further motivate node operators to uphold their integrity. Participants can select where they delegate their stake based on reputation scores assigned to node operators who consistently provide accurate and valid data feeds.

Staking is currently unavailable for non-validator nodes within the Chainlink Network. At the moment, only validators can stake and subsequently earn LINK tokens through the execution of tasks needed to fulfill data requests on the network.

The Chainlink network employs a mechanism similar to Proof of Stake (PoS) to ensure security. In this system, validator nodes stake LINK tokens to gain access to data contracts and receive rewards from the network. 

This incentivized reward system discourages malicious or unethical behavior among network nodes, as they risk losing the LINK they have staked. The Chainlink decentralized oracle network also relies on three purpose-built smart contracts to power and secure its operations.

Aggregation Contract: This contract is responsible for gathering data from various oracles and identifying the most precise results that align with the requirements of the relevant smart contract. Order-Matching Contract: These contracts pair the most suitable oracle with the service level agreement (SLA) criteria specified by the smart contract.

Reputation Contract: This contract assesses the trustworthiness of an oracle by examining its performance metrics, which include metrics such as the total number of completed requests, average response time, and the number of LINK tokens staked by the oracle.

While a groundbreaking solution for bridging smart contracts and real-world data, Chainlink faces several challenges and criticisms.

One key concern revolves around the potential centralization of Chainlink’s oracle nodes. Despite its aspiration for decentralization, many node operators are currently large entities, potentially compromising the network’s core principle. Ensuring a robust, decentralized network is crucial for maintaining trust.

Security vulnerabilities in smart contracts can expose Chainlink to risks. As with any blockchain-based system, coding errors or design flaws can lead to vulnerabilities, and malicious actors may attempt to manipulate oracles. Chainlink must continually improve security to safeguard its ecosystem.

Scalability is another challenge. As blockchain adoption surges, Chainlink must ensure it can efficiently handle a high volume of data requests. Scalability concerns may emerge if the network struggles to meet growing demand.

Chainlink’s reputation system encourages trustworthy behavior among node operators, but trust remains an ongoing challenge. Data reliability fed into smart contracts is only sometimes guaranteed, raising questions about data integrity.

Additionally, costs and complexity can deter smaller projects from integrating Chainlink oracles, potentially limiting its accessibility and adoption. Competing Oracle providers also challenge Chainlink’s dominance, adding uncertainty to the ecosystem.

Addressing these challenges will be critical for Chainlink’s continued success as it strives to revolutionize smart contract capabilities on the blockchain.

The future of Chainlink holds significant promise as it continues to advance the world of decentralized oracles. Chainlink is likely to focus on bolstering security measures, emphasizing enhancing node operator reputation systems, data encryption techniques, and tamper-proof hardware solutions to maintain the integrity of the data it provides.

Chainlink aims to onboard a more diverse set of node operators to achieve greater decentralization and mitigate centralization concerns. This move will make the network more resilient and robust.

Cross-chain compatibility is another frontier for Chainlink’s growth. Expanding its compatibility to various blockchain platforms can facilitate seamless access to real-world data for smart contracts across different ecosystems, fostering interoperability.

Scalability solutions will be crucial to meet the growing demand for blockchain services. Chainlink will likely invest in technologies that efficiently handle increasing data requests while maintaining responsiveness.

Furthermore, Chainlink may develop enhanced privacy features and compliance measures to handle sensitive data securely, making it suitable for industries with strict data privacy regulations. 

The continuous diversification of use cases, integration with emerging technologies, global adoption, regulatory compliance efforts, and ongoing research and development will solidify Chainlink’s leading solution for connecting smart contracts with real-world data, driving innovation in the blockchain ecosystem.

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Asad Gilani Crypto Editor

Asad Gilani Crypto Editor