In this article I will firstly explain what smart contracts are and how they can be used. The second part of this article is focussed on the added value of Chainlink and the ‘oracle problem’ explained. The third part of this article is about concrete use cases of Chainlink in the world of finance. The reason I focus on this vertical is because my background is in finance. Furthermore, I still feel that there is a gap between the developer side of blockchain technology and real world use cases in finance.

Key terms to know before reading:

Blockchains are immutable (unchangeable), decentralized open ledgers. It’s a database that serves all participants, is owned by all participants, but does not belong to anyone in particular and is not controlled by anyone in particular.

are immutable (unchangeable), decentralized open ledgers. It’s a database that serves all participants, is owned by all participants, but does not belong to anyone in particular and is not controlled by anyone in particular. Nodes are the participating computers in the blockchain network.

are the participating computers in the blockchain network. DeFi is an abbreviation of decentralized finance which refers to the digital assets and financial smart contracts, protocols, and decentralized applications (DApps) built on Ethereum.

is an abbreviation of decentralized finance which refers to the digital assets and financial smart contracts, protocols, and decentralized applications (DApps) built on Ethereum. Smart contracts are lines of code that automatically execute a function when a predefined set of agreement(s) / event(s) occurs.

are lines of code that automatically execute a function when a predefined set of agreement(s) / event(s) occurs. API is short for Application Programming Interface. An API is a software intermediary that allows two applications to communicate with each other. It’s the messenger that delivers your request to the provider that you’re requesting it from and then delivers the response back to you.

is short for Application Programming Interface. An API is a software intermediary that allows two applications to communicate with each other. It’s the messenger that delivers your request to the provider that you’re requesting it from and then delivers the response back to you. Oracles feed smart contracts with external information (the most up to date) that can trigger predefined actions of the contract. This external data stems either from software (big data) or hardware (Internet-of-Things). This could be anything from weather temperatures, prices of goods and commodities, payment confirmations to outcomes of the Rugby World Cup.

feed smart contracts with external information (the most up to date) that can trigger predefined actions of the contract. This external data stems either from software (big data) or hardware (Internet-of-Things). This could be anything from weather temperatures, prices of goods and commodities, payment confirmations to outcomes of the Rugby World Cup. Chainlink is a form of digital infrastructure that secures data transmission.

is a form of digital infrastructure that secures data transmission. CBDC is a central bank digital currency.

What is a Smart Contract?

Smart Contracts are digital contracts that are highly reliable by being executed on a tamper-proof, secure and decentralized network (a blockchain, for instance Ethereum). Simply put: a digital self-executing contract with terms of agreement written in code. Their extreme reliability makes it possible to reach agreements about an entirely new level of added value and trustworthiness. The contracts are programmed to specific agreements and are executed as soon as the predefined event occurs.

Contracts itself are nothing new new, contracts are everywhere, for instance in the stock market you have futures contracts or derivatives contracts. Even those ‘traditional contracts’ can be automated using software. The key difference is the tamper-proof aspect, where with a blockchain, the smart contracts will always be executed on the pre-established conditions, and no third party will be able to change this. Clearly, smart contracts are the superior form of a contract.

In order for smart contracts to be useful in the real world, they require external inputs of information. An “oracle” is a third-party information source that allows smart contracts to access off-chain data. The accuracy of this data is really important, because once the smart contract rules are programmed, nor the programmer or the user can change it.

So if the data isn’t true — and being on a blockchain doesn’t necessarily make it so — the smart contract can’t work properly.

Data is fed into blockchains and used for smart contract execution from external sources, specifically data feeds and APIs; a blockchain cannot directly “fetch” data. (These real-time data feeds for blockchains are called “oracles” — they’re essentially the middleware between the data and the contract.)

What is Chainlink — and what does it solve?

Chainlink is a decentralized oracle network that can enable smart contracts to securely gain access to off-chain data, traditional bank payments and API’s. Chainlink has been selected as one of the top blockchain developments by independent research firms such as Gartner. It is well known for providing highly secure and reliable oracles to blockchain startups as well as big corporates (Google, Oracle, Intel, SWIFT and Binance).

So what does Chainlink solve? Most smart contracts currently rely on a single oracle input — one single point of failure — to feed the contracts with external information. Chainlink has developed a decentralized network of independent nodes to perform computations about the accuracy of multiple external data sources before it is written into the code of a smart contract.

“But wait, these oracles already work right, why would you need them to be decentralized?”

The main challenge with (centralized) oracles is that people need to trust an external source of information, whether they come from a website or a sensor (IoT). Since oracles are third-party services that are not part of the blockchain consensus mechanism, they are not subject to the underlying security mechanisms that this public infrastructure provides. And thus a single point of failure.

If oracle security is not provided, companies will not be comfortable with using smart contracts, since it might be fed false information and thus trigger undesired outcomes.

Use cases in the financial landscape

Money is used as a store of value, medium exchange and unit of account. It is used to both value assets and exchange assets. Within the financial system, the use of money is maximized to generate wealth. Since there are high stakes in the market, there is a low trust factor in financial markets and international trade. And some companies or individuals try to influence markets, or don’t fulfil one side of a financial contract.

Smart contracts can bring more trust in financial markets, by eliminating counter-party risk in international trade and probabilistic finance. Financial products (like derivatives) can be automated and verified decentralized without the need for trusted intermediaries that could be biased and thus exert influence and gain value from their position as an intermediary.

The overview of the potential of Chainlink’s connectivity

Derivatives

A derivative is a financial security with a value that is reliant upon or derived from, an underlying asset — the benchmark. The global notional value of the derivatives market is estimated to be between $500 trillion and $1.2 quadrillion. The derivative itself is a contract between two or more parties, and the price of the derivative depends on fluctuations in the underlying asset. They’re used by companies to decrease the risk aspects of an investment or deal by hedging against future uncertainties, such as commodity or currency risk. For instance, a cereal manufacturer and a wheat producer make a deal for a set wheat price in the future, to prevent being impacted by price volatility in wheat.

Chainlink empowers automated execution of derivatives contracts by gathering price feeds from one or multiple sources, aggregating them into a single data point, feeding it into the smart contract for execution, and enabling settlement with any payment output. In a market where companies will avoid payments until they establish positions, Chainlink enabled smart contracts are needed for trust and reliability.

‘Chainlinked’ smart contracts can be a superior replacing infrastructure in the backend systems of derivatives that currently maintain, execute and settle the contracts.

Recently Chainlink also introduced the term Mixicles. Which is an initiative to bring more privacy to DeFi applications on blockchains (like Ethereum). This can create more adoption of public DeFi products, so they can comply with new data security laws such as GDPR.

The value locked in derivatives on Ethereum, source: https://defipulse.com/

2. Remittances

With increasing globalisation, remittances have become a necessity. However, despite technological advancements, remittances are still very expensive and slow. The underlying systems are fragmented and complex. Physically boarding a plane and flying your cash across the ocean is still faster than making a bank transfer intercontinental.

Many blockchain projects are aiming to disrupt the remittance industry. Ripple tries to built a network of banks for international settlements in the XRP token. Both IBM Worldwire (with the XLM token) and Facebook’s Libra try to take a share of the remittances market.

Chainlink oracles can provide reliable data on currency conversion rates to smart contracts, or enable a direct deposit after the transfer has been made.

3. Market Data

With so many exchanges listing different prices for assets, it’s crucial to aggregate multiple data sources to get an accurate price for an asset. Chainlink offers a variety of developer tools to obtain the most up-to-date and trustworthy prices in an unbiased and decentralized manner. This is crucial since there are companies trading millions of dollars based on the price of an asset. It’s important that the price is fair, reliable, and tamperproof to eliminate disputes. Here you can see the accurate price of Ethereum calculated by Chainlink nodes. Chainlink already has external adapters available for cryptocurrency market data from CoinMarketCap, CryptoCompare, Brave New Coin, Binance and Kaiko. This can also be done in traditional markets with for instance Bloomberg, Reuters and NYSE, maybe a future territory for Chainlink?

In this overview you can see how Binance will use Chainlink oracles

4. Tokenization of real world assets

Blockchain networks made it possible to tokenize assets / securities. One of the interesting propositions is creating tokenized assets that can maintain a certain price based off market data fed into the smart contract through Chainlink oracles. Maker DAO (the current market leader in DeFi) already uses 14 oracles to form reference prices for the Maker system.

A wide variety of decentralized products can be created using oracles around tokenizing assets like gold, oil, real estate, art and shipping debt. I see also opportunity around tokenizing stocks to enable 24/7/365 trading.

Another variety of tokenized assets is a weighted basket of assets like the SDR — an international reserve asset offered by the IMF based on a weighted average of five currencies. Which is similar to the backing of cryptocurrency Libra, that is backed by a basket of currencies and US government bonds.

Up until now the tokenized securities market is still in it’s infancy, since there are almost no exchanges worldwide approved yet by regulatory parties to offer secondary markets in these tokens. Although it’s just a matter of time before we trade a lot of real world assets through smart contracts and tokens.

Payments

It’s easy for smart contracts to issue payments in the cryptocurrency of their native blockchain, such as Ethereum smart contracts issuing payments in the token ETH. However, cryptocurrencies are volatile, and thus most businesses are not willing to take the risk of holding it long term. They also don’t want the additional work of trading out ETH for their preferred fiat currency. Given the wide variety of payment preferences around the world, smart contracts need access to many types of payment options to adequately service global demand.

5. Bank payments

Chainlink enables smart contracts to easily connect to existing banking systems, giving developers the ability to create applications that were not possible in the previous data-siloed financial systems. You might wonder whether banks give permission for systems such as Chainlink to connect. Firstly, due to the Open Banking (PSD2) movement, it’s becoming the norm that banks share their API’s publicly. European banks (and soon worldwide) are obliged by this legislation to share data via API’s. This is mainly for AIS (account information services) and PIS (payment initiation services). Smart contracts can be programmed so that once the prefilled conditions are met, an account-to-account payment is automatically initiated via Open Banking API’s. This could decrease the costs for online payments dramatically, while currently Visa and Mastercard dominate the industry.

Smart contract developers can seamlessly integrate with information from consumers bank accounts. Developers can also take advantage of international payment messaging standard SWIFT for cross-border payment functionality.

In this overview you can see how Open Banking API’s relates to third party applications

6. Payments in retail

Many popular consumer applications such as Deliveroo, Booking, Uber, Spotify and AirBnB allow customers to use common retail payment methods. For those companies that would like to use smart contracts, Chainlink can provide easy access to world leading payment gateways, like PayPal, Visa, Mastercard, WorldPay, Venmo and Stripe. Something like Apple Pay or Google Pay should also be possible. Developers can start building applications that take advantage of the most in-demand payment outputs, both domestically and internationally, used on a daily basis in the retail economy. Chainlink has already premade external adapters for payment firms such as Mistertango and PayPal.

7. Payments in Cryptocurrency

Cryptocurrency payments are becoming increasingly popular, but most of these are disconnected from the leading smart contract platforms. Chainlink bridges the gap by allowing any smart contract platform the ability to make payments on any other distributed ledger. This allows smart contracts to trigger payments in Bitcoin, Ethereum, XRP, stablecoins (such as Tether, Libra, CBDC’s), and any other preferred digital currency. Up until now Bitcoin has been more used as a speculative asset / store of value. Some people think it can succeed as ‘digital gold’, an alternative digital store of value. However I think that it needs to accomplish being a worldwide payment system as well, to attract more investors using it as a store of value. Bitcoin’s current transaction costs and time are too high, but developers are working on the ‘lightning network’, which is an ‘off-chain’ micro payments network. This is an interesting development that makes transactions both faster and cheaper. Currently Bitcoin’s marketcap is around $150 billion, while the lightning network capacity is around $7.8 million (still in it’s infancy).

The lightning network is not guaranteed to be widely adopted and as secure as on-chain transactions. However, it might enable off-chain connectivity and enhance Bitcoin’s use as a worldwide payment system. Smart contracts can be used to trigger payments in the lightning network, and guess what these smart contracts need? Decentralized oracles, for secure data transmission to the smart contracts.

More statistics on the Bitcoin lightning network can be found here.

The capacity of the Bitcoin Lightning Network, source: https://defipulse.com/

Conclusion

As you can see there are many potential use cases in Finance for smart contracts and Chainlink. I think decentralized oracles together with smart contracts can revolutionize the way we transfer value online. We are still in the early days of smart contract adoption and the amount of value locked in DeFi applications is still very low. Currently I am working on a fundamental analysis of the Chainlink token and how staking works in the decentralized oracle network. As soon as it’s finished I will post the link in here.

Learn more by visiting the Chainlink website, Telegram or Twitter. If you’re a developer, visit the developer documentation or join the technical discussion on Discord.