What is Chainlink? LINK Explained

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With a price increase of 11.20% in April 2023, Chainlink (LINK) is outperforming the global cryptocurrency market while underperforming when compared to similar Ethereum cryptocurrencies.

Chainlink: A cross-chain crypto project

Chainlink was created back in 2017 by Sergey Nazarov and Steve Ellis, who authored a joint white paper with Ari Juels. Two years later, the Chainlink network was officially launched. 

Chainlink (LINK) is a cryptocurrency that aims to incentivize a global network of computers to provide real-world data to smart contracts on blockchains. It also represents a technology platform that enables non-blockchain enterprises to safely connect with blockchain platforms. Acting as a middleware, Chainlink practically links blockchain-based smart contracts with external data such as stock prices or basketball scores.  

If you are not familiar with smart contracts, we recommend reading this article first: ‘How to use crypto: What are Smart Contracts?’. 

Smart contracts have been used for almost everything in the crypto environment and in relation to a variety of new crypto financial products, services, and assets. However, there was an ongoing issue since most smart contracts still needed to rely on some sort of external data to properly execute their terms. 

For example, if you create a smart contract that aims to replicate insurance agreements, you may need to access external reports on market prices or other types of data.  

This is where Chainlink jumps in – the new technology was created to address the issue of external data by incentivizing data providers or so-called ‘oracles’ to serve as a bridge between blockchain-based smart contracts and external data sources. 

Chainlink network operations are paid by the Chainlink (LINK) cryptocurrency that backs up  smart contracts. The Chainlink ecosystem is built around LINK tokens and the LINK network.

Understanding the Chainlink Network

Chainlink is a decentralised oracle network. Blockchain oracles usually refer to decentralised services with a common objective – to forward data from off-chain resources onto blockchains. An oracle can be a general-purpose, compute-enabled interface between and among on-chain and off-chain systems. 

In the blockchain ecosystem such technologies enhance the functionality, performance, and interoperability of smart contracts.  

Chainlink on Twitter: "With #Chainlink Functions, smart contract developers can access APIs from the world’s largest data providers in just a few minutes. Building in #Web3 has never been easier. Get started: https://t.co/0fOY5wvp7u https://t.co/ByBYsxFbfH" / Twitter

Chainlink uses blockchain technology to safely enable computations on and off-chain, supporting hybrid smart contracts. Hybrid smart contracts fuse running on the blockchain with data from outside the blockchain provided by decentralised oracle networks. 

The Chainlink blockchain is hosted on the Ethereum platform that uses the Proof-of-Stake operating protocol. To learn more about Ethereum, we suggest reading our ‘Crypto Basics: What is Ethereum’ article.  

What problems does Chainlink solve?

To understand Chainlink's architecture and the problems it solves, it is advised to gain insight into nodes within blockchain networks and blockchain bridges. This may sound complicated at first so we suggest reading this article first: 'Crypto Basics: What are Blockchain bridges & how do they work?'.

With the Chainlink decentralised oracle network technology as a springboard, the Chainlink crypto project plans to advance several areas. Let’s explain them briefly. 

Smart contracts connectivity problems

The smart contracts technology has been called out for its inability to interact with resources running outside the node network. Smart contract developers cannot create more if there is a lack of connectivity. 

 We can spot this problem in a simple example. Many apps use multiple data feeds. Think of, for example, the Uber app. Uber uses GPS data and key outputs such as payment gateways to provide convenient services for everyday use.  

Without being able to properly link off-chain resources, smart contracts remain bound to the on-chain data only. Without access to outside world data, such apps cannot function properly. Most apps already function properly in terms of external inputs and outputs. 

Chainlink brings to the table the solution of how to integrate them into smart contracts in a manner that retains the most value to end users. 

The issue of centralised oracle services

An oracle can be defined as an agent that provides valuable information on outside-world events. Before smart contracts came to the scene, digital agreements were embedded in code that could have been changed, terminated, or even deleted by a party that exercises control over it. 

If you are a frequent reader, you may remember how we have examined oracle networks and services in our 'Crypto Basics: What is an Oracle in Blockchain?' article.

Smart contracts are a true game changer because they deliver decentralised, tamper-proof, and self-executing contracts.  

Problems emerge when smart contracts execute in reliance on only one centralised source of data because then the nature of decentralisation loses its main point. If all existing oracles amount to centralised services, using them introduces a single point of failure. In such cases, smart contracts are as secure as traditional centralised digital contracts.  

On the other hand, a truly decentralised network works by spreading the network's data and power across multiple connection points or nodes. Each node is controlled by a different individual, and no one can harbour total control over the network or smart contract.

A new niche market

Chainlink is part of a niche market of decentralised oracles. This crypto project doesn’t compete with any of the major players such as Bitcoin, Solana, or Ethereum. Instead, the Chainlink project became a third layer of blockchain technology that assists other blockchain platforms. 

Chainlink’s only market competitor at the moment is Band Protocol – another cross-chain oracle data provider. However, Chainlink still holds a monopoly over the oracle market since its competitor isn’t close to Chainlink in terms of integration and technology. 

Incentive-based (crypto-economic) security

Designing and robustly deploying mechanisms that ensure nodes in decentralised oracle networks have strong economic incentives to behave in a reliable manner is one of the bases of Chainlink’s technology.

According to Chainlink, it is important to ensure that nodes have a financial incentive to behave accurately. The project uses staking in blockchains to prevent attacks and render misconduct.  

Incentive-based security is founded on a super-linear staking impact and the Implicit-Incentive Framework (IIF), an incentive model Chainlink creators have devised to encompass empirically measurable incentives beyond explicit deposited staking funds. 

This answers the question of how the Chainlink network is secured. A similar concept to Proof-of-Stake is used by Chainlink, enhanced by a reward system that prevents network nodes from committing misconduct.

How does Chainlink work?

Chainlink uses divergent nodes to attain the requested data. Nodes form a consensus before returning data to the smart contract. Due to this function, a smart contract doesn’t rely on a single oracle. Chainlink nodes have the ability to conduct both one-time and multiple-time data retrieval tasks. 

There are two interactive parts of the Chainlink network: the on-chain and off-chain components. 

On-chain component

The on-chain component is made of oracle-based contracts on the Ethereum blockchain. Their purpose is to monitor and process end users’ data requests. 

When there is a request for off-chain data, they transfer the request to the Chainlink network where it is processed into a native blockchain smart contract. Subsequently, these Chainlink smart contracts match such requests with suitable oracle services. 

User contracts have the ability to charge the Chainlink oracles a penalty fee for inaccurate information. This adds up to the incentive system we mentioned in this article. Its main purpose is to provide a fair and reliable service to end users. 

The Chainlink network has two interactive parts: the on-chain and off-chain components. 

Off-chain component

The second part of the Chainlink architecture encompasses off-chain oracle nodes that link to the Ethereum network. 

Such nodes gather responses to external requests. Individual responses are summed up through the use of several consensus mechanisms and turned into a single global response and converted into a contract. The harvested data is processed via Chainlink Core, a vital element that links the blockchain and off-chain data resources. In simple words, Chainlink Core is a device that translates off-chain data and sends it to an on-chain oracle. 

In all of these stages and components, what role does LINK play? For the services provided by Chainlink node operators, smart contracts that request data pay them in LINK tokens.

Therefore, off-chain nodes are compensated with LINK tokens. This adds up to the integration of external adapters that are created by developers to perform many sub-tasks, making the data gathering much more productive. 

Types of Chainlink smart contracts

We mentioned earlier in the text that Chainlink brought to life the use of hybrid smart contracts. A hybrid smart contract is an application that is made of two parts: a smart contract and a decentralised oracle network. These two elements interact with one another efficiently and securely connect to form a single hybrid smart contract application.

As a result, we get an on-chain code that is augmented in a variety of significant ways. The use of these innovative smart contracts opens up many new use cases that would not be possible through on-chain code alone due to financial, technical, and legal constraints.

The whole process regarding different types of smart contracts starts on a blockchain when a smart contract requires data. The Chainlink protocol registers a request for information as an 'event' and creates a Chainlink Service Level Agreement (SLA) Contract to get off-chain data. The Chainlink SLA Contract generates three-sub contracts. Let's explain them briefly.

First, we have Aggregation Contracts. An Aggregation contract is a type of smart contract that is used to collect data from oracles and match the most correct results with the smart contract that needs them. 

Secondly, there are Order-Matching Contracts. An Order-Matching Contract is used, as the name suggests, to match a smart contract’s service level agreement (SLA) with the best bidding oracles. 

Finally, Chainlink uses Reputation Contracts. A Chainlink Reputation Contract verifies an oracle’s integrity by checking its track record. A track record includes factors such as the total number of completed requests, average response time, and amount of LINK tokens the oracle has staked.  

As for the track records, it is significant to point out that the Chainlink network aggregates and weights the data provided using an oracle reputation system, which can determine the reliability of the data sources. Data providers get paid for their services if everything goes well.

What is Chainlink's LINK token?

The Chainlink network is, in a number of ways, a complement to the Ethereum network and other popular blockchains. Being an ERC-20 token built on the Ethereum platform, LINK is compatible with other currencies and smart contracts supported by the Ethereum platform. 

ERC-20 is a standard for fungible tokens such as cryptocurrencies, which can also be used to give token holders voting rights in decentralised autonomous organisations (DAOs). To learn more about various Ethereum token standards, why not read this article: ‘How to build crypto? What is Ethereum’s architecture?’. 

Use cases of LINK

LINK tokens are used in the Chainlink decentralised network to compensate node operators for the retrieval of data from external data sources, turning it to blockchain readable format and off-chain computation.  

For example, if someone aims to use an Ethereum smart contract enhanced with a Chainlink node, they can do so with LINK tokens. The Chainlink node operator establishes the final price according to the demand for the off-chain resource and the supply of similar data. 

The currency can be further used for staking, either implicitly and explicitly. Implicit staking means that the current and future revenue of Chainlink nodes is denominated in LINK tokens, incentivizing the proper operation of the Chainlink network. Explicit staking means that Chainlink nodes in the future may be required to lock up LINK tokens as collateral to back their oracle services, which can be slashed for various types of misconduct. 

To learn more about crypto staking, why not read this article: 'How to earn crypto: What is Staking? Earning Rewards and Minimising Risks of Staking'.

Why does LINK token have value?

In simple terms, the LINK currency gets its value from its ability to ensure successful executions of smart contracts within the Chainlink network. The cryptocurrency is built into the decentralised network itself and presents the only currency that can be used for vital network operations.  

As mentioned above, LINK tokens are used to pay node operators to retrieve data. However, LINK also plays a significant role in administering interactions between Chainlink end users. 

The LINK cryptocurrency is used as a deposit required by the smart contract holders and paid for by the oracles. This fee is refunded if their services have not been accepted or as soon as they efficiently finish the task. If the oracle fails to complete the task in question, smart contract creators may keep the fee. 

Total supply, market cap, and valuation of LINK tokens

Similar to many other cryptocurrencies, the supply of LINK tokens is limited as well. According to the Chainlink software rules, there will only be 1 billion LINK. 

As of April 2023, 5he market capitalization of Chainlink LINK amounts to $4.15 billion. Market cap is measured usually by multiplying token price with the circulating supply of LINK tokens which equals 520 million tokens at the time of writing. 

The fully diluted valuation of LINK is little over $8 billion. This is a statistical representation of the maximum market cap, assuming all of 1 billion LINK tokens are in circulation.