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Price Oracle
- A Must Have Infrastructure
October 8, 2020
We Uplift DeFi
We Connect DeFi
We Witness DeFi
hello-defilabs@huobi.com
Table of Contents
Overview
Price Oracle: a Must-Have Infrastructure
Problems With Current Oracles
Oracle Sector Review
Oracle Protocol Review
Price Feed Comparsion
Risk Factors
Delay and Volatility
Data Analysis
What Does This Mean For The Future Of DeFi?
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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Overview
With the exponential growth of decentralized finance protocols over the past
12 months and the growing interest from other corners of the cryptocurrency
market to DeFi, we have witnessed a tremendous shift in crypto market
narrative from centralized to decentralized finance.
However, for DeFi to truly achieve its goal to disrupt traditional finance and
transform the entire financial industry to be more efficient and transparent, the
space still has a long way to go. And one of the key obstacles that it needs to
overcome to inch closer to this goal is the oracle problem.
Price Oracle: A must-have infrastructure
The problem with the blockchain world is that Dapps cannot directly
communicate with off-chain information to enable further innovations such as
dispute settlement, liquidation, risk management which all require off-chain
data to be fed into the smart contract. This is where price oracles serve as an
essential component of the DeFi space - price oracles are the “connectors”
between the on-chain and off-chain worlds, delivering data generated by real-
life, off-chain events on-chain and thus trigger a series of smart contract
execution.
Decentralized financial services offered by the current mainstream DeFi
platforms such as MakerDAO, Compound, dYdX, etc. rely heavily on the price
oracles to provide the data necessary to carry out smart contract operations
such as determining liquidation prices, margin trading, and lending. Price
oracles act as a reliable source of information to feed these critical data to
these DeFi platforms. As such, price oracles are an integral part of the
decentralized financial services infrastructure.
Problems With Current Oracles
Decentralized finance is unconventional, and we have observed a few
differences when comparing it with the traditional finance industry.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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Lack of viable options to conduct proper risk
management
In traditional finance, when institutions talk about investing, trading or having
market exposure, the first thing they think of is usually risks. Quantifiable risks
form the foundation of the financial market and are crucial for market
participants to make informed investment decisions. In DeFi, however, we have
barely seen any analysis and recognition of such risks, not to mention
incorporating quantifiable risks into the DeFi infrastructure. In other words, as
of today, market participants have not been able to comprehensively
understand risks in DeFi, nor can they properly calculate and hedge them.
Time in the on-chain world is discrete rather than
continuous, measured on a block by block basis
In the off-chain world, time elapses continuously and the market has evolved
over time into having an complicated price discovery mechanism based on the
continuous timeline. As such, a market’s price discovery is almost always more
efficient in the centralized world than the decentralized one.
However, in the on-chain world, time elapses discretely and the smallest unit of
time in the blockchain world is known as the block time.
Due to this time structural difference, we argue that DeFi applications should
not compete with their centralized counterparts for being the destination of
price discovery. Instead, these applications should bring their unique
competitive advantages to the game, creating exclusive experiences in the
decentralized world. Unfortunately, the current DeFi ecosystem is still building
infrastructure based on the centralized mindset.
Existing designs of automated market makers (AMMs)
rely on arbitrageurs to ensure that prices on AMM DEXs
do not deviate from actual market prices
Because the traditional financial market has become fairly efficient through
years of evolution, arbitrage opportunities are hard to come by. However, the
current AMM-based DEXs heavily rely on arbitrageurs to help approximate true
market prices, implying an inefficiency in the design of the DeFi infrastructure.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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Liquidity providers (LPs) are not compensated enough for
having market exposure on volatile assets
There are various market frictions in the centralized trading world such as
latency and transaction fees. These frictions are also true in the decentralized
world, and DeFi LPs are not being compensated enough for bearing the cost
incurred by these frictions.
Given the concerns listed above, we believe that the blockchain infrastructure,
specifically price oracles, should be built upon the following design principles.
Given the concerns listed above, we believe that the blockchain infrastructure,
specifically price oracles, should be built upon the following design principles.
• Enable computable risks
• Consider time as discrete rather than continuous, with the smallest unit
of time as blocks
• Meet the non-arbitrage condition
• Incorporate time delay, market volatility and transaction costs when
compensating the LPs
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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Overview of the Price Oracle Sector
The demand for oracles heightened in recent months as more DeFi protocols
are being launched.
As seen in the charts below, between May 1, 2020 and September 1, 2020,
the 30-days rolling gas fee for oracle project Chainlink showed a 32.2x surge,
while the standard gas fee on the Ethereum blockchain only jumped by 26.9x
during the same time period.
• Chainlink 30-days rolling gas fee and standard gas on Ethereum blockchain
Source: ETH Gas Station
$937K 199 Gwei
$1,000 $200
$667 $133
$333 $67
$29.1K 7.4 Gwei
May 01 Sep. 01 May 01 Sep. 01
Chainlink and another oracle project, NEST Protocol, were among the
top 10 Ethereum gas gazers on September 1, 2020, ranked #5 and #7
3%
5%
respectively. Both protocols rose to prominence within a short period
3%
6% of time - on May 1, 2020, Chainlink was ranked #11 while NEST
Protocol was not on the list.
Ethereum
Gas
Distribution 45% The gas distribution during the period between August 15, 2020 and
37% September 15, 2020 also shows that NEST Protocol and Chainlink are the only
two non-DEX projects in the top 10 Ethereum gas usage leaderboard
(excluding Tether USD and SmartWay Forsage, which is a pyramid scheme).
Uniswap V2 Tether USD
NEST Protocol 1inch Exchange
ChainLink CHI Token
Unlike in yield farming, there is limited hype in the oracle sector, especially with
NEST Protocol. Even with the recent DeFi hype, the google search index of
keyword “blockchain oracle” was near zero for 80% of the days over the past
three months. Being the must have infrastructure in the industry together with
a low google search index, implying huge potential for further development.
• Compare of Google search index: DeFi and blockchain oracle Blockchain Oracle DeFi
Source: Google Trend
100
67
33
2020/6/11 2020/7/26 2020/9/8
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comOracle protocol review
There are essentially two types of oracles, centralized and decentralized ones.
Coinbase Price Oracle is a notable example of a centralized oracle. It takes
Coinbase Pro’s API as the data source, then excludes data points with
significant deviation. DeFi projects wishing to request data feeds can make
calls to Coinbase Price Oracle with public key verification enabled.
Although centralized oracle is an easy way to fulfil the off/on-chain data gap,
we have only seen a few DeFi projects utilising it, largely due to security
concerns - an attacker can control the oracle data sources and then broadcast
malicious information to a smart contract that relies on the data, thus
contaminating the decentralized trading environment.
On the other hand, decentralized oracles have been widely accepted by the
DeFi ecosystem. DeFi applications such as lending, derivatives, and some
DEXs all need a reliable oracle to access price data in order for them to
function properly and fairly.
• Total Value Locked (TVL) of DeFi projects with oracle integration
Source: DeFi Pulse
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comIn this report, we investigate four decentralized oracle projects: Chainlink,
NEST Protocol, Band Protocol, and Tellor, each of which have been created
based on various design principles and with different levels of decentralization.
• Chainlink provides price feeds for 55 trading pairs, including 30 fiat pairs.
More than $2.3B locked values in crypto assets are referencing Chainlink
price oracle as of September 14, 2020.
• Band Protocol aims to provide a price feed service on multiple public chains,
including Ethereum, Polkadot, and Cosmos. Beyond cryptocurrencies,
Band Protocol can also connect to trusted data sources (i.e., weather,
lottery, and unemployment rate) through traditional Web APIs with
customised oracle script.
• Tellor takes the old fashion Proof of Work (PoW) method combined with the
staking concept to maintain data quality. Users can request data by adding
TRB token as a tip.
In a macro view, the three oracles mentioned above have structured their price
generation model as shown in the process below.
• Decentralized oracles price generation process
Due to the on-chain validating requirement, these decentralized oracles may
fail to update when the market experiences extreme volatility, like the one on
Black Thursday, due to network congestion and extreme market conditions.
The process of on-chain validation needs voting by transaction, which
consumes extremely high gas fees during peak blockchain network activities.
Even if sufficiently high gas fee has been utilised, voting can still encounter
blockchain propagation issues.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comNEST Protocol, on the other hand, proposes a different way to solve the
problem of providing prices on-chain through a decentralized incentive solution
called quotation mining. In a nutshell, the quotation mining system consists of
two types of participants
1: Makers which consist of miners and verifiers 2: Callers. Anyone can become
a miner to provide quotation and pay commissions in return to receive NEST
tokens. On the other hand, verifiers can challenge the miner’s quotation by
staking 2x equivalent amounts of asset to update the price if the previous
quotation price deviates from the true market price.
Each of the current DeFi projects brings some elements from traditional finance
to smart contracts, with the lending sector considered to be the largest by total
• TVL by DeFi sectors on Sep 28, 2020 value locked as shown on the left. However, we argue that the majority price
Source: DeFi Pulse
oracles are too centralized which only report data on short tail assets. Out of
$0.69B
the top 100 cryptocurrencies on Coingecko which have a combined value of
es
iv
at
$328B, roughly 22% of the $328B assets has not yet been reported by
iv
er
D
$4.16B
decentralised oracles.
s
EX
D
$4.73B We believe the DeFi ecosystem should not pick and choose on what asset
g
in
nd
data should be reported by the price oracles. Instead, these decisions should
Le
$2 $3 $5
12% be made by the community. However, when reporting data on long tail assets,
we run into the problem of attacks. The maximum penalty to maliciously
3%
attack an oracle node by reporting incorrect price data is the amount of
1% assets that the attacker staked. The monetary value could be
1% significantly less than the potential profit earned if a successful attack
2% can be executed, generating an incentive for malicious attackers to
Oracles exploit the protocol.
Supported
Assets Market 22% NEST protocol presents a properly designed structure to eliminate these
Cap
58%
potential attack vendors. A malicious attacker may tamper with a normal
quotation price, however, the attacker must stake 2x the amount of assets in
Source: CoinGecko order to challenge the previous quotation price. The attacker either leaves
significant arbitrage opportunities to the market or must continue to self report
BTC ETH
XRP SNX and continue staking 2x of the previous amount of assets in order to sustain
BCH LTC
the attack. The costs of an attack can become exponentially large within
Others No Price Feed
an hour of the attack and raise to almost the total number of ETH in the
entire market. This design makes NEST protocol attack resistance in the
sense that it can completely eliminate dishonest players in the system.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comPrice feed comparison
Oracles are in charge of price feeds. The donut chart on the left demonstrates
a simple comparison about methods for oracles to generate data and how
those data are validated. Chainlink uses price data from nodes with LINK
tokens as collateral. Though anyone can run a Chainlink node, the Reference
Data Feed is generated still by permission. Currently, Chainlink has 21 trusted
parties for its ETH-USD pair with 0.5% deviation threshold.
In Tellor's ecosystem, users can request price feeds by giving TRB tokens as
incentives. Miners quote price with PoW competition; and the median of the
first five price feeds will be saved on-chain. Users are able to dispute the price
feeds within one day after price feed generation.
NEST Protocol allows miners to participate quotation mining by staking base
token and quote token with an off-chain price; i.e., staking 10 ETH with $3,800
USDT means Ethereum (ETH) has a current market price of $380. The
arbitrager (Taker) can challenge the quoted price by performing a swap for
both ETH and USDT within 25 blocks (i.e., T0 ~ 5 mins) if the arbitrager
believes that the price quoted by the miner is incorrect.
In the meantime, the arbitrager needs to provide an updated quote and stake
2x amount of asset. When no one challenges the quotation price within 25
blocks, effectively meaning that the price meets the non-arbitrage
condition, this quotation price then becomes the NEST- price, which can then
be used by other DeFi applications. On the other hand, there is no
verification process for other price oracles and thus no way to ensure the
price data reported by other oracles meet the non-arbitrage condition.
In addition, NEST protocol can achieve on-chain price updates for every
block under the most efficient scenario. Since the smallest unit of time is
the block time in the on-chain world, price updates on every block is the
most efficient way that can be achieved.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.com• Price Feed Comparison of Decentralized Oracles
Data Generation Nodes price feed PoW with Median DPoS Quotation Mining
Selection
Validation or Dispute Slash and Slash Slash Arbitrage
reputation mode
Price Feed Threehold By pairs N/A N/A Min. Cost of
arbitrage
Heartbeat 2 hrs N/A N/A Min. One block
Key Risk Factors Price delay and price deviation
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comThe unique risk factors value
proposition
Price delay and price deviation are two key risk factors presented in all
oracle infrastructure. Network congestion or a lack of price feed can cause
price delay causing price deviations. These two risk factors can influence the
performance of other DeFi platforms relying on these oracles.
Unfortunately, there is no way to eliminate price delay and price deviations due
to the fact that the off-chain world runs on continuous time, but the on-chain
world runs discretely by block.
As a result, after an asset’s price undergoes the process of being transmitted
through the oracle from off chain to on-chain, it also becomes different from the
quoted price of the off-chain exchange.
In fact, the transfer of asset experience from off-chain to on-chain will produce
three different prices with small deviations: exchange quotations, oracle
theoretical feed prices, and on-chain quotations (true price generated by
Oracles). Behind the difference between these three prices are two easily
overlooked risk factors: 1: delay 2: volatility.
• Deviations between on-chain and off-chain price
When a node inputs a price When an agreement is obtained When it was written into a block
On-chain price
on-chain Δt1 Oracle theoretical Δt2
referenced
feed price (Pt+Δt1)
( P̃ t+Δt1+Δt2 )
Off-chain (St)
Changes of asset price (Volatility) Off-chain
off-chain (St+Δt1+Δt2)
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comDelay and volatility
P̃ t (the true price of oracle) is a delayed version of St . For different
oracles, delay may be from different origins.
For Chainlink, reasons for delay includes: from when nodes inputs prices to
aggregation to the time when an agreement is obtained (delay between St and
Pt) , and the time to write it into a block. (the delay between Pt and P̃ )
For NEST Protocol, the delay between St and Pt can be ignored (suppose
sufficiently price-inputers), and the delay between Pt and P̃ t is accurate 25
blocks or roughly around 5 minutes.
Besides, there are other reasons for the delay between true price generated by
the Oracle ( P̃ t) and optimal input price (Pt):
① Malicious attacks to the oracle
② Large price changes
③ Transaction blocked/delayed in the blockchain system
For all price oracle protocols, market volatility matters. Since the on-
chain and off-chain world runs in parallel with different time structures, price
differences are naturally presented between the off-chain and the on-chain
world due to time delay. However, when the market volatility is higher, price
differences can experience some even larger gaps.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comData analysis
This section presents a data-driven analysis of the differences in ETH/USDT
prices between price oracles (i.e., NEST Protocol and Chainlink Oracle1) and
1: Chainlink launched ETH/USD Huobi Global exchange, using historical data ranging from August 30, 2020 to
aggregation while NEST Protocol provides
September 16, 2020.
ETH/USDT reference price. In this
analysis, we assume the difference
between USDT and USD is negligible. We discovered that the ETH/USDT price from the oracles matches Huobi
Global exchange’s off-chain price data closely with some extremely small
deviations.
• ETH/USDT price analysis
Source: explorer, reputation.link
Then we further calculate the spread between Chainlink’s and NEST’s ETH/
USDT prices and exchange price. Most of the time the NEST Protocol’s price
spread (red dots) is smaller than Chainlink’s (blue dots). The absolute number
of Chainlink’s average price spread ($0.494) is 31x as much as NEST’s
($-0.016).
This finding affirms that the NEST Protocol’s price data can be more properly
referred to in the decentralised world based on its accuracy.
• Price Spreads Stats • Price spreads analysis
Source: explorer, reputation.link
Price spread ($) Chainlin Nest
k
Highest 23.431 11.130
Lowest -9.999 -17.885
Range 33.43 29.015
Average 0.494 -0.016
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comThe results of the spread analysis indicate that the price spreads between
September 2 and 6 were relatively large, which we believe was related to the
higher gas fee and ETH/USDT price volatility on the Ethereum network during
the time. For Sep 2 2020, the Ethereum average daily gas price is roughly
around 480 Gwei.
• Ethereum Network Gas Price in Gwei
Source: Etherscan
We have further analyzed the standard deviation of 1440 minutes rolling price
spread and the results have shown that the standard deviation of the Nest’s
spread was only 0.21% to 1.30%, while for Chainlink it ranges from 0.97% to
2.01%, again we have verified that the NEST Protocol has a more reliable
quotation design.
• Moving average standard deviation analysis
Source: explorer, reputation.link
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
www.huobidefilabs.io hello-defilabs@huobi.comWe extracted data between Sep 5 and Sep 14, 2020 for deeper analysis. Both
NEST Protocol’s and Chainlink’s highest absolute number of average daily
spread prices occurred on Sep 5, 2020. ETH/USDT quotation price from Huobi
Global exchange fell by more than $76 on that same day. While Sep 14, 2020
presents a relatively low price volatility market.
The below analysis shows that Chainlink’s reference prices (red dots) provide
much less price data than NEST Protocol, which means Chainlink has a lower
frequency of quotation under a stable market, due to its design.
Chainlink is set to trigger the oracle updates when the off-chain price fluctuated
for over 0.5%. Otherwise, there will be no price update for as long as 10800
seconds. While in NEST Protocol, anyone can become a miner providing
quotations to earn NEST tokens. With a higher frequency of quotation, Nest’s
reference price tracks more closely to the Huobi Global’s than Chainlink’s.
• ETH/USDT Prices on Sep 5 and Sep 14, 2020
Source: explorer, reputation.link
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comThe analysis of price spreads also confirms the above view. The deviations of
the two oracles’ price spreads from zero is different under different market
conditions. On Sep 05, 2020, when the market was in a higher volatility, the
deviation is larger than that under the lower price volatility market.
Under the same market condition, the deviations from zero for Chainlink’s price
spreads (blue dots) are worse than NEST Protocol’s (red dots) for most of the
time.
• Price Spreads on Sep 5 and Sep 14, 2020
Source: explorer, reputation.link
Our interim analysis shows that prices provided by NEST Protocol match more
closely with those from the centralised exchange. In contrast, Chainlink as one
of the price oracle infrastructures demonstrated subordinate performance in
terms of price reliability.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comWhat does this mean for the future of
DeFi?
The current DeFi ecosystem can be described as CeFi running on blockchain,
although the space continues to strive for decentralization, innovation, and
permission-less. We believe that the current DeFi market structure can be
considered as DeFi 1.0, where some of the most critical legos pieces in the
DeFi blueprint such as lending, trading, derivatives, price oracles, etc have
been built to support the early stage ecosystem in the past few years.
We have demonstrated that current DeFi price oracles can be more accurate
and reliable to support further innovation in the space. Major players such as
Chainlink offer a solution to solve the most important issue in the decentralised
world - connecting off-chain data with on-chain data. However, its reliability,
accuracy and the decentralised nature are called into question when compared
with the NEST oracle supported by in-depth data analysis.
As DeFi grows, however, DeFi 1.0 no longer satisfies all the market demands,
especially those coming from sophisticated market participants. As such, we
need DeFi 2.0, or what we call, CoFi, Computable Finance.
To resolve the problem that current financial risks in DeFi lack computability, a
redesign of the price oracle infrastructure is likely part of the solution. At the
end of the day, a sustainable DeFi ecosystem will be the one where market
participants can be compensated by bearing certain risks, and these risks can
be computable in such a way that they allow market participants to properly
quantify hedge these risks if necessary.
In the CoFi world, we envision the reshape of the most important DeFi
infrastructure - the price oracle - entirely from the ground up to attract
meaningful market attraction, deliver accurate and timely data information,
enable computable risks, and meet the non-arbitrage condition.
Disclosure: Huobi DeFi Labs has provided financial support to CoFiX, a community driven DeFi protocol
that’s built on the NEST oracle.
Price Oracle - A Must Have Infrastructure by Huobi DeFi Labs
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www.huobidefilabs.io hello-defilabs@huobi.comReferences
[1] Uniswap v2 Core
https://uniswap.org/whitepaper.pdf
[2] Bancor Protocol
https://storage.googleapis.com/website-bancor/2018/04/01ba8253-
bancor_protocol_whitepaper_en.pdf
[3] The Math Behind PMM
https://dodoex.github.io/docs/docs/math
[4] NEST Protocol
https://nestprotocol.org/doc/ennestwhitepaper.pdf
[5] How Accurate the NEST Price Is
https://nestprotocol.org/doc/NEST_Price_Performance.pdf
[6] Trading Compensation of CoFiX
https://cofix.io/doc/Trading_Compensation_CoFiX.pdf
[7] CoFiX Product Documentation
https://docs.cofix.io/
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