What Is Chainlink Crypto? Best Explanation with Examples

Published: January 10, 2024 | Last Updated: December 4, 2023

Markos Koemtzopoulos

Markos Koemtzopoulos is the founder and main writer of ElementalCrypto. He has been a lecturer at the University of Nicosia on cryptocurrencies and DeFi and has taught two courses on crypto and blockchain technology.

In this post, I will explain what Chainlink crypto does in the simplest way possible. I kept hearing about Chainlink prior to researching it but I hadn’t realized just how big a player they are in the crypto ecosystem. In this post, I will walk you through what Chainlink is, how it works and give you some concrete examples instead of complicated crypto terminology.

To understand Chainlink you need to have a rudimentary understanding of how blockchains work. If the words Ethereum and smart contracts don’t mean anything to you then I suggest you start by understanding how the Ethereum Network works first or follow my free Crypto 101 tutorials

What’s Chainlink

Chainlink allows smart contracts on blockchains to access real-world data in a decentralized manner. 

For example, I might write a piece of code to automate insurance.

Say my code accepts monthly payments of DAI tokens from farmers who want to be insured against catastrophic weather events.

In case there is a flood, the smart contract in my application will pay out $100,000 in DAI whenever the precipitation in an area is more than 40mm which indicates there’s been a massive flood. 

Accepting the payments and making the payout is extremely easy. This is the type of thing that a blockchain that supports smart contracts does well.

It’s how the whole industry of decentralized finance applications was born. You can borrow and lend, exchange, and invest all in a decentralized and automated manner. 

But how do you trigger the payout without a central referee to give the green light?

A blockchain can’t know the rain precipitation in Nebraska. It needs access to information that lives outside of the blockchain.

This data needs to be trustworthy, timely, and available in a decentralized manner. This means it should not be dependent on one single authority. 

And it’s not just weather data that blockchains don’t have access to. There’s a myriad of other data feeds such as asset prices, sports scores, sensors, web data, enterprise systems, and more that are not available on a blockchain.

This is where Chainlink comes in. Chainlink is a decentralized network of oracles. 

What’s an Oracle? 

crypto oracle

In the context of crypto, an Oracle acts as a trusted source of information that fetches data from the external world and relays it to a smart contract.

A decentralized oracle network relays this information without needing to rely on a single source of data. 

Continuing with our crop insurance example the blockchain’s smart contracts could connect to a number of weather data providers such as:

  1. National Oceanic and Atmospheric Administration (NOAA)
  2. OpenWeatherMap 
  3. Weatherstack 
  4. The Weather Channel
  5. AccuWeather 
  6. Apple Weather
  7. Weatherbit
  8. ClimaCell
  9. National Weather Service (NWS)

Oracles will aggregate data from multiple sources to validate the data. This can help in cross-referencing and comparing information to identify and filter out outliers or inaccurate data.

For example, say you have set up a decentralized borrowing and lending app.

The app accepts ETH as collateral and gives out DAI as a loan. To do that the app needs to know the price of ETH. This information is not something that is available on the blockchain since it is determined by the crypto market overall. To find the price the app can hook up to an ETH/USD price feed which sources the data from multiple oracles.

chainlink oracle price feed
Chainlink’s ETH/USD price feed

Let’s take a look at some more use cases:

Chainlink Use cases

  1. Chainlink is extensively used in DeFi applications to provide accurate price feeds.  This ensures that lending protocols, decentralized exchanges, and other financial instruments have reliable and tamper-proof price information.
  2. In the insurance industry, Chainlink facilitates the creation of smart contracts that automatically trigger payouts based on external events, such as flight delays, weather conditions, or other verifiable parameters.
  3. Chainlink offers Verifiable Random Functions (VRF) to gaming and NFTs. In gaming and e-sports for example you want randomness to be generated fairly. This ensures fairness in gaming outcomes, rewards, and other in-game events that require verifiable random numbers. 
  4. Smart contracts in supply chain management use Chainlink to access real-world data, such as tracking the location of goods to pay out an invoice. Kinda similar to VeChain.
  5. Chainlink supports the tokenization of real-world assets, such as real estate or art, by providing secure and reliable data about the asset’s value, ownership history, or market conditions.
  6.  Chainlink oracles can be used to verify real-world identity information, which would help bring DeFi and other apps into the mainstream.

See Is Chainlink Actually Used for more specific examples

What is LINK? 

The chainlink token is called LINK. 

LINK tokens are used to pay Oracles for the off-chain data they provide from the outside world.

The token is generated using the ERC-20 token standard which means that it lives on the Ethereum blockchain.

LINK has a total supply of 1 billion and a market cap of just under $8Bn at the time of writing. Its market cap reached an all-time high of $22Bn in May 2021. See instructions on how to get Chainlink here.

Chainlink price graph
Chainlink price. Source: Coinmarketcap.com

You can easily buy LINK on any cryptocurrency exchange including Coinbase, Binance, KuCoin and Kraken.

How does Chainlink work? 

Chainlink relies on a network of nodes.

Chainlink node operators are entities that run software nodes on the Chainlink network. These nodes are an integral part of the Chainlink oracle network, which connects smart contracts on blockchain platforms with real-world data, external APIs, and various external sources.

Key responsibilities of these operators include:

  1. Data Retrieval: Node operators connect to external data sources from the real world, such as price information, weather data, or any other data required by smart contracts. See Where Chainlink Gets Its Data for more details.
  2. Data Aggregation: In some cases, multiple Chainlink oracle nodes may retrieve and aggregate data from various sources to provide a consensus data point. This helps enhance the accuracy and reliability of the data fed to smart contracts.
  3. Data Validation: Nodes make sure that they are retrieving accurate data. This involves checking for data tampering or manipulation.
  4. Blockchain Communication: Nodes transmit the verified data feeds back to the blockchain
  5. Job Execution: Node operators execute predefined tasks, known as jobs, as specified in the smart contracts. These jobs may involve fetching, aggregating data points, and delivering data to fulfill the requirements of the smart contracts.
  6. Security Measures: Node operators implement security measures to safeguard the integrity of the data and ensure that the Oracle network is resilient against potential attacks.
  7. Reputation Management: Chainlink incorporates a reputation system for node operators. Nodes that consistently provide accurate information are rewarded and build a positive reputation within the network.
  8. Economic Incentives: Node operators are often rewarded with LINK tokens (the native cryptocurrency of the Chainlink network) for their services. Economic incentives are designed to encourage nodes to provide reliable and timely data. In addition some nodes are required to stake LINK to guarantee their data. See my Chainlink staking guide for more.

What’s Chainlink 2.0

Chainlink 2.0 is an upgrade to the overall chainlink ecosystem and allows decentralized Oracle networks to perform off-chain computation.

Think of it like this:

Imagine it’s 2009 and you are about to create an app that connects users to car drivers. You decide to call it Uber and code up the app. Once you’ve done the basics you need to connect to external providers. You need Google Maps API for location data, Stripe for payments, and Twilio to send SMS messages. Congratulations you are on your way to becoming a billionaire. 

But how do you do the same when you want to make a DeFi app? You would write the core smart contract code on a blockchain but then to orchestrate the retrieval of data, payments, and everything else that has to happen you would need to hook up to external providers in a decentralized manner  

Where Chainlink 2.0 comes in. 

Consider that there are three categories of activity:

  1. First, you have on-chain activity. This is the smart contract code itself. 
  2. Next, you have an off-chain activity which is the real-world data: market events, weather, computing systems, and backend systems in banks; Essentially everything happening outside the blockchain
  3. Third you have a decentralized meta layer that sits between the two. Chainlink started with hundreds of decentralized Oracle networks offering different services. Chainlink 2.0 envisions expanding to 1,000s of Oracle networks that provide their own services and that can now also provide computation. This means that instead of just giving you data they will also process data. 

This can be done in a trust-minimised way.

For example, you could have tens of nodes doing the same computation and storing the final results. The networks can then arrive at a consensus about what the truth is. 

Also, Chainlink 2.0 can do computation on data that you didn’t want to do on a blockchain for cost computation or complexity reasons.

Background

Chainlink was founded by Steve Ellis and Sergey Nazarov both of whom had a deep interest in coding, philosophy, and digital currencies. They saw the need for blockchains to speak to the real world when the first blockchains incorporating smart contracts emerged. In 2017 they  raised $32 Million through an initial coin offering and founded Chainlink Labs

Chainlink founders
Chainlink founders Sergey Nazarov (Left) and Steve Ellis (Right)

So is Chainlink a big deal? 

Yes, Chainlink is helping the world transition to an upgraded and better world that does not need to rely on trust for things to work. It helps to eliminate information asymmetries and levels the playing field.

A lot of things are broken because of trust issues and a lack of definite truth about what happened. 

Chainlink delivers hype-reliable automation. With Chainlink you go from probabilistic “just trust me” promises to cryptographically guaranteed outcomes no matter what. 

Going back to the insurance example, when you take out insurance today you look for an entity that signals trust. A brand with a logo that says, “I have been around for 100 years, trust me” is your best choice.

That’s worked okay-ish up until now.

But we are now moving to proof of code that doesn’t need a brand attached to it anymore. The code guarantees outcomes objectively regardless of how you access it. You no longer need to rely on paper guarantees and are relying on cryptography instead. 

What’s wrong with the current system?

There are plenty of examples where “just trust us” has not worked.

People think that the current system works. But what control do you have over your money at a bank or broker in the world of traditional finance?

All you need to do is look at the subprime mortgage crisis of 2008. Knowing that those mortgages were rubbish was not publicly available information. Imagine if it had all been publicly available on-chain. We wouldn’t have wiped out billions across economies around the world.

Or consider when Robinhood, the popular brokerage app, paused trading activity for Dogecoin or Gamestop. 

Or consider my country, Greece. Banks are the safest place to keep your money right? Well, your opinion on that might change when one day you wake up and you are only allowed to withdraw 66 euros per day like I found out one sunny morning in 2015. 

Chainlink co-founder Sergey Nazarov predicts everything will use smart contracts: insurance, derivatives, equity ownership, carbon credits, and ad networks are just a few examples. And each of these will combine with each other to create new products we had not even thought were possible. He envisions a world where there will be no room for fraud and no need for trust in a single third party. 

Blockchains give people the world they thought they had. It’s better for society. 

Sergey Nazaarov

Useful Resources

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Markos Koemtzopoulos is the founder and main writer of ElementalCrypto. He has been a lecturer at the University of Nicosia on cryptocurrencies and DeFi and has taught two courses on crypto and blockchain technology.