DEVELOPMENT
Key takeaways
Interconnecting realms within and beyond the network, oracles grant blockchains entry to real-world data. Yet, instances of past exploits stemming from oracle manipulation serve as a stark reminder that utilizing oracles can instigate concerns surrounding trust and reliability.
By eliminating reliance on oracles, protocols devoid of oracle dependency emerge as a strategic means for projects to combat price manipulation, enhance self-sufficiency, and reduce costs associated with oracles.
Exploring the mechanics of oracle-free protocols, we delved into various projects spanning lending, derivatives, and non-fungible tokens. Notably, we observed inventive solutions that facilitate pricing, liquidation, and other essential mechanisms without leaning on oracles.
While oracle-free protocols present a viable alternative to the prevailing oracle-centric landscape, it’s crucial to acknowledge the tradeoffs linked to complexity, efficiency, and design limitations that must be carefully weighed.
Looking ahead, we envision ample opportunities for the development of both oracle-free and oracle-dependent protocols. Recognizing the tradeoffs inherent in each solution, developers and users alike may discover distinct use cases where one approach proves more fitting than the other.
The oracle problem
Linking the realms within and outside the network, oracles empower blockchains with access to real-world data, spanning from cryptocurrency prices to soccer match outcomes. This external data can be seamlessly integrated into cryptographic processes, broadening the functionality of blockchain networks.
While oracles enhance the capabilities of blockchain by enabling tasks based on real input data, they simultaneously introduce trust and reliability concerns. Real-world data, being inherently non-deterministic (e.g., varying bitcoin prices across exchanges), necessitates trust for the reliability of oracle results, contradicting the typical trustless execution associated with smart contracts.
Moreover, oracles serve as potential weak points susceptible to manipulation, as evidenced by numerous instances of price oracle manipulation in the past. These manipulations have resulted in substantial financial losses, with an estimated $892 million attributed to oracle-related manipulations over the past three-plus years.
Participants often exploit low-liquidity tokens on targeted protocols, artificially inflating prices before exchanging them for other tokens or leveraging them as collateral for loans on credit markets. However, there has been a notable decrease in losses due to oracle-related exploits in 2023, likely attributed to heightened security focus and a significant decline in Total Value Locked (TVL) in the decentralized finance (DeFi) space.
Figure 1: Since 2020, more than $892 million has been lost due to Oracle-related exploits.
Let’s go without Oracle
Recent investigations have delved into the aforementioned concerns tied to oracles, marking significant strides in addressing these issues. The teams behind oracle development have made substantial advancements across various domains, such as decentralization, transparency, and data verifiability.
In a hypothetical scenario, envision a world where reliance on oracles has been entirely eradicated. In this context, how would blockchain projects navigate the absence of external data? This is where the concept of oracle-free protocols takes center stage.
As the term implies, oracle-less protocols operate independently of oracles. They employ alternative mechanisms to achieve comparable outcomes, offering several advantages:
Mitigation of Oracle-Related Price Manipulation: Oracle-free protocols, detached from external price flows, render manipulation by fraudulent actors impossible.
Enhanced Security and Autonomy: Relying on third-party oracles increases the protocol’s vulnerability to potential attacks. Autonomy, achieved through oracle-free protocols, diminishes the risk associated with oracle vulnerabilities.
Cost Reduction: By eschewing oracles, protocols save on fees that would otherwise be incurred.
Examining specific case studies sheds light on how protocols function effectively without the reliance on oracles.
Lending
Traditional lending protocols commonly lean on oracles to acquire pricing data, especially for the liquidation process. However, this reliance introduces a vulnerability: the prospect of oracle price manipulation. Exploiting this weakness allows attackers to distort price dynamics, rapidly depleting the platform’s funds. Examples like the Mango Markets hack last year and the recent attack on EraLand in July underscore the real-world risks associated with such exploits. To counter these vulnerabilities, several protocols have emerged with oracle-free solutions that eradicate the dependence on external price feeds.
In the realm of decentralized finance (DeFi) lending, existing oracle-free solutions can be broadly categorized into two models: peer-to-pool and peer-to-peer.
The peer-to-pool model tackles the oracle reliance issue by permitting the creation of pools without authorization, shifting pricing responsibility to users. Since pool parameters are sensitive to market dynamics, this approach necessitates active position management.
Conversely, the peer-to-peer model simplifies lending and borrowing by enabling direct interaction between both parties to establish loan terms.
To provide practical insights into each model, we examine two case studies below. It is important to note that mentioning specific projects is not an endorsement or recommendation by any entity. Instead, these projects serve as examples to illustrate the discussed concepts. Conducting additional due diligence is essential for a comprehensive understanding of the projects and their associated risks.
Figure 2: Illustration of peer-to-peer and peer-to-peer models
Ajna Finance
Launched in July 2023, Ajna stands out as a peer-to-pool lending and borrowing platform that operates without reliance on governance or external price feeds. It seeks to tackle two enduring challenges in the DeFi space: capital inefficiency for long-tail assets and dependence on price oracles. Ajna addresses these concerns by necessitating user vigilance over their positions and enabling permissionless pooling with flexible parameters.
The mechanics of Ajna Finance revolve around three key features designed to eliminate dependencies on oracles:
1. Creating a pool without authorization
2. Lending with liquidity ranges
3. Liquidation Bond
On Ajna, users have the ability to establish closed pools that combine lending and borrowing transactions for specific tokens backed by designated collateral tokens. Pool creators independently set initial interest rates for each token pair, with rates adjusting based on utilization every 12 hours in 10% increments.
Compared to other protocols, lending on Ajna demands a higher level of active management. Lenders must choose a price or “price segment” at which to lend their assets. These segments correspond to different liquidity types, each associated with varying levels of risk and reward. The liquidity types are classified based on their state—whether active, ready for use, or unused—and influence parameters such as Threshold Price (“TP”), Neutral Price (“NP”), and Lowest Usage Price (“LUP”).
These dynamic parameters impact interest earned and determine whether a position is over-collateralized or under-collateralized. Given the dynamic nature of these parameters, influenced by borrowing and lending within the pool, active management of positions is essential.
The liquidation process on Ajna differs from traditional lending protocols. A position faces liquidation when the TP of the loan exceeds the LUP of the pool. Any user can initiate liquidation by posting a liquidation bond on the loan, essentially betting on the outcome of the collateral sale. This user-driven intervention eliminates the need for oracles in the liquidation process.
Essentially, Ajna sidesteps the reliance on external price feeds by empowering users to employ their pricing channels. Both lenders and borrowers must actively manage their positions according to market prices to avoid liquidation or loss of interest.
It’s crucial to note that Ajna is a relatively new platform, with only two months of existence at the time of writing. Users are advised to conduct their own due diligence before engaging with the protocol, considering potential risks such as recently discovered grief vectors that may impact borrowers.
Figure 3: Illustration of how an over-collateralized loan becomes under-collateralized
PWN Finance
PWN Finance emerges as a peer-to-peer lending protocol uniquely crafted to accommodate a diverse range of fungible and non-fungible assets, all without relying on pricing oracles or credit pools. This platform fosters direct communication between borrowers and lenders, empowering them to establish personalized lending terms. These terms, spanning short to long durations, adhere to various token standards such as ERC-20, ERC-721, and ERC-1155.
The mechanics of the PWN loan process unfold through four pivotal steps:
Borrowers initiate the process by listing their collateral and loan requests, specifying details like asset type, loan amount, and loan term.
Lenders present borrowers with their terms and conditions for consideration.
Upon agreement, borrowers receive the loan amount, and lenders acquire a deed to the borrower’s claim. Notably, deed tokens are transferable, affording lenders the flexibility to exit their positions at any point.
At the term’s conclusion, borrowers can either repay the loan with interest or, in the event of default, lenders can demand collateral.
PWN Finance’s peer-to-peer model operates as the most direct form of lending, circumventing the need for oracles, as borrowers and lenders establish a predefined set of loan terms from the outset. Given the fixed term of the loan, lenders can only seek collateral if the borrower fails to repay at the term’s end. This design ensures that fluctuations in collateral value during the loan period do not trigger liquidation, providing PWN with the ability to function without relying on an oracle.
Nevertheless, it’s essential to acknowledge that lenders bear the risk of collateral value falling below the loan value at the term’s end. In such scenarios, borrowers may be incentivized to forfeit collateral instead of repaying the loan, placing lenders in a potentially precarious position.
Figure 4: PWN Finance loan process
Derivatives
Derivatives represent financial instruments whose valuation is contingent on the performance of underlying assets. Within the DeFi derivatives realm, price oracles play a pivotal role in facilitating liquidation processes and determining the outcomes of derivatives contracts.
A recent trend has emerged in the derivatives landscape, marked by the advent of protocols that operate without relying on oracles. Presently, these solutions predominantly leverage automated market makers (AMMs), such as Uniswap V3, as their foundational layer.
On leveraged trading platforms, the foundation of traders’ positions rests on liquidity provider (LP) tokens. These LP tokens inherently encode the value of the underlying asset, alongside variables like liquidity ranges. This intrinsic encoding eliminates the necessity for pricing oracles to ascertain asset prices.
In the context of option protocols, where Uniswap V3 LP positions essentially function as short sell positions, developers capitalize on this feature to redefine option pricing mechanisms without recourse to the traditional Black-Scholes-Merton (BSM) model, thereby circumventing the need for oracles.
The subsequent section delves into two prominent examples, providing a more in-depth exploration of the foundational concepts underpinning these derivatives protocols.
InfinityPool
InfinityPools stands out as a leverage exchange platform with a bold vision—providing limitless leverage for any asset pair without the risk of liquidation or the reliance on oracles. Aspiring to become the new DeFi primitive, the platform employs concentrated liquidity market makers (CLMMs) as its foundational layer, enabling leveraged positions backed by liquidity provider (LP) tokens. This strategic approach ensures ample liquidity for liquidating leveraged positions, with trade pricing predetermined by the mathematical structure of the LP tokens.
It’s crucial to note that InfinityPools is currently in the developmental phase and undergoing public beta testing. Information provided is sourced from publicly available channels, and readers are encouraged to conduct their own research.
The mechanics behind InfinityPools’ oracle-free operation revolve around two key components:
Floating pool LP token-based positions
Leveraged trading on InfinityPools occurs within the floating pool, a liquidity pool owned by the protocol and structured as a concentrated liquidity pool akin to Uniswap V3. Vendors contribute UNI V3 LP tokens or direct liquidity to this pool, which is then accessible to traders seeking to open leveraged positions. Traders’ positions are based on borrowed LP tokens, and the redemption of these tokens is required, with the redemption value matching the originally borrowed amount. Collateral requirements for traders are determined by the liquidity range associated with each LP token. This unique structure not only eliminates the need for external price feeds but also guarantees sufficient liquidity to collateralize each leveraged position.
For instance, if a trader borrows a $2,000 ETH/USDC LP token and places it in a liquidity band centered at $1,800, they must repay the $2,000 regardless of whether the price of ETH rises or falls. To ensure repayment in the event of an ETH price drop, a deposit of $200 or 0.11 ETH is required. The entire mechanism operates autonomously within the protocol’s liquidity pool and is defined by the CLMM LP mechanism.
InfinityPools introduces an innovative approach to leverage, leveraging the distinctive features of CLMM LP tokens. In theory, positions are non-liquidating and can be established with extremely high leverage. However, leverage is still somewhat constrained by the liquidity range, and the tradable assets depend on the availability of liquid assets.
Figure 5: A simplified illustration of the InfinityPools structure.
Panoptic
Panoptic stands out as a groundbreaking oracle-free options protocol, providing a distinctive avenue for online options trading. The Panoptic team has astutely recognized parallels between Uniswap V3 LP payouts and put positions, leading to the development of a pioneering pricing and trading method that bypasses the need for a Black-Scholes-Merton (BSM) model. Unlike traditional models reliant on oracles for real-time data inputs, Panoptic’s abandonment of the BSM model underscores its independence from oracles for option pricing variables like underlying asset price and volatility.
It’s worth noting that Panoptic is currently undergoing closed beta testing, and readers are advised to conduct their own research to gather comprehensive insights.
The mechanics of Panoptic’s oracle-free quality hinge on its unique option pricing methodology known as Streamia—a term denoting a continuous stream of option premiums. In contrast to the common use of the BSM model in traditional option pricing, Streamia eliminates the need for an oracle by determining the commission based on whether an option falls within a specified range. In Panoptic, option prices are path-dependent, increasing with each block if the spot price remains within the strike price range.
For instance, if an option seller initiates a position in the USDC/ETH pair with a $2,000 strike price and a $1,800 market price of ETH, and a width of 10%, the range limits are set at $2,200 and $1,818 ($2,000/1.1). Streamia commissions accrue when the price is within this range (between USD 2200 and USD 1818) and remain unaffected when the price is outside this range.
In a nutshell, Panoptic’s options mechanics involve sellers providing collateral—either borrowed from liquidity providers or self-provided—which is then deployed to Uniswap V3. Conversely, option buyers use Panoptic to borrow and transfer the seller’s LP tokens back into the Panoptic pool. This intricate process of moving funds between Uniswap V3 and the Panoptic pool, coupled with an option-based payout structure for LP positions and the seamless flow of liquidity, introduces a novel dimension to options trading on Panoptic.
Figure 6: Panoptic liquidity dynamics
Non-Fungible Tokens (NFTs)
Conventional DeFi lending practices commonly rely on pricing oracles, a trend that extends to NFT-powered lending protocols. However, this reliance on oracles not only introduces a potential single point of failure but also grapples with challenges tied to accurately valuing assets, particularly when it comes to establishing minimum prices for NFTs and objectively pricing individual NFTs with varying rarity characteristics.
The emergence of oracle-free NFT lending protocols presents a promising shift, offering an alternative paradigm to existing solutions. These protocols predominantly adopt a peer-to-peer model, facilitating direct connections between borrowers and lenders. This approach enables both parties to establish loan terms based on their own assessments of the collateral’s value and potential, unencumbered by third-party intervention and the need for external price flows. To delve into their fundamental mechanics, we examine two examples below.
Blend
Blend, launched in May 2023 through a collaborative effort by the Blur and Paradigm teams, stands as a peer-to-peer open-ended lending platform. Distinctively, Blend pioneers a new liquidation mechanism, coupled with a peer-to-peer model, to entirely eliminate the need for oracles. This groundbreaking approach empowers both lenders and borrowers to autonomously define loan terms aligned with their respective financial objectives. Key variables like interest rate, loan-to-value (LTV) ratio, and loan duration dynamically respond to market conditions, offering enhanced flexibility for all parties involved.
The mechanics of a Blend loan unfold in the following steps:
Lenders designate a specific collection of NFTs they are willing to accept as collateral for an ETH loan.
Once the borrower accepts the offer, the chosen NFT collateral is encapsulated within a smart contract.
The loan, once established, becomes permanent and can be terminated by either the lender or the borrower.
Initially, lenders make choices regarding the NFT collection deemed suitable as collateral, specifying the maximum lending amount and the interest rate. Upon the borrower’s acceptance of these terms, the NFT collateral is locked, initiating the accrual of interest by the lender.
Both parties retain the option to close the loan. Borrowers achieve closure by repaying the principal plus interest, while lenders can instigate a loan refinance. The refinancing process operates as a Dutch auction in the interest rate domain, commencing at 0% and incrementally increasing until another lender intervenes or a predetermined limit is reached. At this juncture, the loan is deemed insolvent, triggering liquidation and enabling the lender to claim the collateral.
Blend introduces an innovative exit/liquidation mechanism in the form of a Dutch auction, obviating the need for oracles. Instead of relying on external sources to determine liquidation timing, creditors wield the authority to initiate liquidation at their discretion. This empowerment, however, necessitates active monitoring of positions by creditors, who must intervene if the risk/reward ratio no longer aligns with their strategic objectives.
Figure 7. Dutch auction scenarios
NFTfi
NFTfi stands out as another peer-to-peer lending protocol specializing in fixed-term loans secured by NFTs. Much like Blend, NFTfi innovatively eliminates reliance on oracles by operating as a peer-to-peer matching platform, facilitating direct negotiations between borrowers and lenders. Notably, while NFTfi focuses on providing fixed-term loans, Blend offers open-ended loans, creating distinct risk and reward profiles for their respective user bases.
The mechanics of an NFTfi loan unfold as follows:
Borrowers list their NFTs, specifying their desired loan terms.
Lenders submit competing NFT offers, seeking potential opportunities.
A loan is established when the borrower accepts one of the offers.
At the conclusion of the loan term, options include extensions or foreclosure by the lender if the borrower is unable to repay the loan.
The process commences with borrowers listing their NFTs and outlining their preferred terms. Lenders, aiming for interest-only opportunities, submit their terms, aware that they may face competition from other lenders interested in the same NFT. Once a loan is initiated, the borrower receives the loan amount, and the NFT is securely deposited in a smart contract. Loan agreements can unfold in two ways: the borrower repaying the debt or the lender foreclosing on the loan in the event of borrower default. Significantly, NFTfi introduces the flexibility of renegotiating loan terms both before and after repayment, offering both parties the opportunity to adapt terms if timely repayment becomes challenging.
NFTfi seamlessly operates without reliance on oracles, employing a peer-to-peer model that allows borrowers and lenders to negotiate terms based on the market value and potential of specific NFT collections. The inclusion of a renegotiation feature adds an extra layer of adaptability, empowering users to adjust terms in response to changing circumstances.
Figure 8. How NFTfi works
The perfect solution? There isn’t one.
While the absence of reliance on oracles provides a level of insulation from the associated risks, it’s crucial to recognize that oracle-free protocols, like any solution, come with inherent tradeoffs that demand consideration from both developers and users.
Greater Complexity: The implementation of workarounds to minimize reliance on oracles tends to introduce a higher degree of complexity to oracle-free protocols. Users may find themselves burdened with additional responsibilities, such as increased position monitoring (e.g., manual tracking of asset prices), the necessity for more sophisticated risk-return ratio analysis (e.g., evaluating acceptable credit terms for loans), and the potential exposure to losses (e.g., in cases where collateral value falls below the loan value).
Without Oracle in Theory, Not Necessarily in Practice: While a protocol might theoretically operate without depending on oracles, the practical reality is that users often need to turn to external data sources to make informed decisions. In some instances, these data sources may still be intertwined with oracles or centralized data providers.
Reduced Efficiency: Liquidation processes in protocols lacking an oracle are typically less straightforward than their oracle-dependent counterparts. Instead of automatic liquidation triggered by a predefined price threshold, oracle-less protocols may require manual intervention by users, leading to potential time delays and diminished efficiency.
Greater Design Limitations: The absence of a seamless mechanism to incorporate external data through oracles can impose limitations on protocol design. Some protocols may lack support for certain functionalities, like elimination.
In essence, eliminating oracle dependency is a challenging endeavor, demanding alternative mechanisms to achieve comparable results. These workarounds introduce additional layers of complexity, posing a potential hurdle to widespread adoption.
However, it’s crucial to recognize that moving beyond oracle dependency is just the initial phase. The subsequent challenge lies in simplifying these processes to ensure that oracle-free protocols remain robust and user-friendly, fostering broader acceptance and usability.
Perspectives and final thoughts
Oracles play a crucial role in the cryptoecosystem, acting as a vital link between the on- and off-chain realms by providing real-time data and ensuring the seamless functioning of numerous DeFi protocols. However, the use of oracles presents a double-edged sword, introducing vulnerabilities that attackers can potentially exploit.
Oracle-free solutions emerge as enticing alternatives, aiming to alleviate the associated risks of relying on oracles. Yet, the adoption of these alternatives is influenced by various factors, making them more suitable in specific cases. For instance, the peer-to-peer model within oracle-free solutions might be apt for NFT lending, given the distinct characteristics and sparsity levels of NFTs, as indicated by the predominant borrowing volumes observed in peer-to-peer NFT protocols. In the realm of DeFi, the majority of protocols still lean on oracles. Encouragingly, oracles have demonstrated significant progress in recent years, enhancing security and decentralization.
Looking ahead, the landscape isn’t simply a competition between oracle-dependent and oracle-less protocols. Each comes with its own set of advantages and disadvantages, finding relevance in distinct scenarios. While oracle-free protocols may attract specific user groups due to their unique mechanics, the decision between oracle dependency or independence is unlikely to be the sole criterion guiding most users. Project teams will need to assess which mechanisms and structures align better with their objectives to determine the most appropriate path forward.
