Chainlink is a decentralized application built to solve the oracle problems of smart contracts. This is the Chainlink beginner’s guide. It explores the history of the project, the use of LINK token, and Chainlink’s technology.
Chainlink is a decentralized application and a token
Let’s first place Chainlink in the correct cryptocurrency category. This is an interesting project with very few direct competitors. We usually divide cryptocurrencies into three categories: currencies, platforms, and tokens.
Bitcoin and Litecoin are examples of digital currencies. These coins do not have any other essential functions in addition to transferring and storing value.
Platforms, on the other hand, provide an ecosystem for smart contracts and decentralized applications (Dapp). You can think of them as being like Android or iOS. The most well-known platform is Ethereum, and other popular projects are Cardano, Solana, and Avalanche.
Tokens are always issued on a platform, which means tokens don’t have their own blockchain. Tokens have typically a use case in a specific Dapp. They are either utility tokens or governance tokens.
Chainlink belongs to the token category. Originally, it was software built on Ethereum. These days Chainlink is running on dozens of different platforms as well.
Below is a short introductory video from Chainlink’s website.
The name Chainlink can refer to the entire project or the token, which is using the ticker LINK. This is an ERC-20 token compatible with the Ethereum blockchain. Though, some of the LINK’s supply is also on other blockchains these days.
Chainlink is operated by SmartContract Ltd. The company is founded in 2014 and is headquartered in San Francisco. SmartContract’s CEO is the cryptocurrency expert Sergey Nazarov (see the photo below). He has been involved in the industry since 2011.
Another key figure is Steve Ellis. He is currently the CTO of SmartContract Ltd. Nazarov and Ellis are often named as founders of Chainlink. You can find the whole team on this page.
Chainlink has been developed for years. It caught the attention of the crypto world when its ICO was held in September 2017. The project raised a fairly moderate pot of $32 million when compared to the entire ICO market. Chainlink’s white paper was published in September 2017 as well.
The project stayed out of the limelight for the first year. LINK token’s price dropped in 2018 with the whole market. At the time Chainlink was a very unknown project, but 2019 changed everything.
Chainlink’s MainNet was released in May 2019 on Ethereum. It was a result of six years of work. At the same time, Chainlink started to gain publicity, which accelerated LINK to hundreds of percent price increase during the summer of 2019.
Chainlink’s listing on Coinbase also helped. Many active investors found the project around this time. The graph below shows the price development of LINK from 2017 to 2021.
The year 2020 was an excellent one for Chainlink. LINK token jumped from about $1.8 to $12 within that period. The price rise continued in the spring of 2021 and LINK reached its peak in May 2021, as did many other cryptocurrencies.
Chainlink’s price development went hand in hand with the DeFi market. This makes sense because Chainlink is integrated into every major DeFi protocol. In 2021, however, there was a significant change.
Total liquidity of the DeFi sector continued to grow after the bear market of May-July 2021. DeFi has also expanded to more platforms, and Chainlink is an important part of this puzzle. LINK token’s price development has been disappointing in this respect. Investors put their money into smart contract platforms instead such as Terra, Avalanche, and Solana.
Chainlink also released a 2.0 version of its white paper in 2021. The biggest topic of 2022 is staking. We’ll get back to this later in the article.
Basic information about smart contracts
Chainlink’s whole purpose revolves around smart contracts. Ethereum brought smart contracts to the mainstream, but they are also supported by all competing platforms.
The term smart contract has risen to even wider awareness since 2020 – thanks to the rise of the DeFi sector. Smart contracts are the components that all decentralized applications are built of.
The term smart contract is actually a bit misleading. It is not necessarily a contract or a particularly smart one. A smart contract is just a piece of code that carries out predetermined orders. You can read our in-depth guide for more information.
Smart contracts are stored in the blockchain. Transactions directed to them are always processed when creating new blocks.
In the Ethereum platform, smart contracts are programmed using Solidity language. Smart contracts are processed by the Ethereum Virtual Machine (EVM), which is running on each node on the network.
Many of Ethereum’s competitors have built their platform to be EVM compatible. This means that Dapps built on Ethereum can be easily cloned and transferred to competing platforms.
Smart contracts and oracles
Smart contracts have one fundamental limitation: they cannot read data outside the blockchain.
For example, a smart contract stored in the Ethereum blockchain can only use information from the Ethereum blockchain. The same logic applies to other blockchains. This limits the potential of smart contracts significantly.
However, there is a solution. An external source of information can be connected to a smart contract with an oracle. Ancient oracles were thought the portals through which gods spoke to people. In the world of blockchains, oracles have a bit different role.
An oracle is a program that reads for example cryptocurrency price data and transfers this information to a smart contract. There can be unlimited examples of data an oracle could provide. If you’re just thinking about the DeFi market, every Dapp needs 100% reliable price feeds from different blockchains to operate.
The Internet of Things (IoT) brings a whole new use for oracles. Think of a self-driving car, for example. It can send huge amounts of information to the blockchain about traffic volumes and different components of the car. Such sensors are called hardware oracles.
What does Chainlink have to do with oracles? Let’s look at it next.
Chainlink solves the decentralization issue
First of all, you should note that Chainlink has not invented oracles or smart contracts. Both have been around for a long time. Chainlink has been developed to solve decentralization issues between smart contracts and oracles.
Even if a developer creates a decentralized application (Dapp), the data feed might still depend on a centralized source. A service provider could send incorrect information to the Dapp intentionally. There are also other technical problems that must be considered. If a data feed breaks or the project is subjected to a cyberattack, the Dapp will be compromised.
Chainlink was created to solve these problems. The solution is to create a decentralized network of oracles.
Chainlink founder Sergey Nazarov has used the term middleware when referring to the project. Chainlink is an application between smart contracts and external information. It makes it possible for smart contracts to keep the decentralization and integrity they are built for.
Here’s an example of Bitcoin’s price data. The image below is from Chainlink’s data page of the Ethereumin network. Currently, Bitcoin’s dollar price is provided by 31 different oracles.
Trusted answer refers to the price delivered by Chainlink’s oracles. Each oracle gives a slightly different answer, after which Chainlink forms an average of them. The more oracles there are the more reliable the data.
This is where it’s important to differentiate Chainlink from Cosmos and Polkadot, which want to link blockchains to each other. These are called interoperability projects or the internet of blockchains. That is not the case with Chainlink.
Although Chainlink launched on Ethereum, it is no longer just an Ethereum application. Chainlink is now integrated into dozens of different blockchains and hundreds of applications. It can be seen as a large decentralized application or collection of API connections that developers can take advantage of.
Chainlink has also launched the term hybrid smart contract. This means a combination of a traditional smart contract and an oracle network linked to it. Read more on Chainlink’s website.
LINK token, VRF, and Proof of Reserves
Chainlink has become famous for its oracle network. An important part of this is the LINK token. The entities that order Chainlink’s services pay for data feeds using LINK. This creates a constant demand for the token since the need for data feeds is likely to increase in the future.
Providing external data is not the only feature of Chainlink. Another popular data feed is called the Verifiable Randomness Function (VRF). This basically means a random number generator. One might think that picking up a random number is an easy job. However, this is not the case. Ensuring randomness is not that simple.
The need for VRF has increased with the NFT sector. The video below shows an example of the Aavegotchi NFT, which is drawn random features using VRF.
An application that needs randomness sends a seed to Chainlink’s oracle network and the random number is generated based on this.
As its name suggests, Proof of Reserves refers to a certificate of reserves. For example, DeFi applications, lending services, and stablecoin issuers have a need for this. Users can verify through PoR that the service has the required collateral and reserves. The certificate produced by the decentralized oracle network is much more convincing than a certificate written by the service itself.
Everyone who has followed the project has come across staking. This has been discussed since 2019 but staking is still not launched. The year 2022 will finally make a difference. According to Sergey Nazarov, staking will soon become reality. However, no exact date has been set yet.
Staking in the #Chainlink Network is set to be released within this coming year 👀
This comes as multiple Chainlink oracle networks have reached profitablity based on user fees alone
— ChainLinkGod.eth (@ChainLinkGod) January 1, 2022
The lack of staking has become a problem for Chainlink. Mainly for investors for the time being. Since Chainlink is not a smart contract platform and does not have its own blockchain, there is no natural staking available for the LINK token.
Staking has a significant impact on the price of smart contract platform native tokens. Between 65% and 75% of the tokens in circulation are staked. These tokens will therefore be out of the market, which will reduce supply and give a boost to the price.
Chainlink’s staking means a slightly different thing than for smart contract platforms. Staking is performed by the nodes of the Chainlink network. LINK tokens can be staked to make higher revenues and motivate the node operator to provide valid data. A hostile node could lose its staked tokens.
Please note that Chainlink’s staking is called explicit staking and super-linear staking. They mean the same thing. Staking is explained in the video below in a beginner-friendly way.
The purpose of the staking is to prevent attacks on the oracle network. The more LINK is staked by the operators, the harder it is for the attacker to bribe oracles to send inaccurate data.
At this point, a new second tier is also brought into the system.
Second-level operators make sure that the data generated by the oracle network is valid. If any of the oracles suspect that other operators are sending inaccurate data, it can report them to second-tier “cops”. These second-tier operators reward the declarant by providing it with LINK tokens owned by fraudsters.
This creates a strong incentive to do the right thing. If someone wanted to bribe oracle operators to produce misinformation, the reward should be higher than the combined value of staked LINK by other operators. The larger the oracle network grows and the more LINK tokens are staked, the safer the system becomes.
Security will become increasingly important in the future as the combined liquidity of the Dapps using Chainlink grows from hundreds of billions of dollars to trillions of dollars. The incentive to manipulate data also grows.
In conclusion, staking is much more complex for Chainlink than for traditional smart contract platforms. You can find comprehensive information on Chainlink’s website. You might want to get familiar with it.
What about investors who don’t run their own oracle node? LINK token delegation is likely to become available. There will be more information about this during 2022.
Chainlink has grown enormously in the last couple of years. The popularity has been significantly influenced by the growth of the DeFi market. Two years ago, the total value locked in the DeFi sector was about $300 million, and a year ago about $700 million. Today’s figure is about $250 billion!
Check defillama.com for up-to-date information.
At the same time, the number of DeFi applications has exploded. The entire ecosystem has also expanded from Ethereum to other smart contract platforms.
It is easier to pick up significant blockchains that are not yet integrated into Chainlink’s oracle net. At the time of writing this article (1/2022), Chainlink has over 1,000 partners! Of these, 724 have come in 2021. Chainlink’s oracle network is integrated into 89 different blockchains, and the service is used by over 500 different DeFi applications.
You can explore partners from chainlinkecosystem.com/ecosystem/.
Chainlink collaboration agreements are not limited to DeFi apps. Internet giants Google and Amazon are also partnering up.
Chainlink makes an average of 20 partnerships every day.
Investing in Chainlink
Let’s talk about Chainlink as an investment. The fundaments are good, but why was LINK such a poor investment in 2021? Chainlink’s price is now (1/2022) at the same level it was in January 2021. LINK has also dropped outside the top 20 in the cryptocurrency rankings.
The enormous growth of the DeFi sector and 700+ new collaboration agreements support Chainlink’s growth, at least in theory. In practice, this is not reflected in LINK’s price, as the demand for oracle services is not high enough. Those who operate oracles also sell their LINK payments for dollars, just as Bitcoin miners do with bitcoins.
Chainlink staking will change the playing field. The lack of staking has been a big issue for LINK tokens, which is why it has fallen behind many smart contract platforms in the rankings. Staking will also attract more institutional players.
Chainlink staking can have a significant impact on the LINK price. When will the staking be available? This is still a big question mark. Of course, investors can speculate and purchase LINK tokens in advance.
You should also take a look at the Coin Bureau video below. It introduces the remarkable collaboration agreements, staking, and reasons for LINK token’s weak price development in 2021.
The video also mentions sales by the Chainlink Foundation to fund the development of the project. These LINK token dumps have contributed to the price decline.
Investors should also remember that Chainlink is not the only oracle network on the market. However, its position is really strong compared to its competitors. Band Protocol received a lot of attention in early 2021, but now its ranking has dropped to 300th place. Other challengers are WINKLink and API3.
Chainlink is a critical piece of the entire crypto infrastructure. Nor does its popularity show any signs of abating. It is likely that there will be more partners at an ever-increasing rate.