Welcome back to another edition of the Captain BTC Newsletter!
In this edition, we’re going to do a deep dive into Chainlink, one of the fundamentally most important blockchain projects in the space. The original vision for Chainlink was to provide external data onto the blockchain as a decentralized oracle solution. With the release of the Chainlink 2.0 whitepaper, the use cases and possibilities are much much greater than a simple oracle data feed. It will become the middleware infrastructure for this entire ecosystem. Chainlink does not compete with any blockchain, it improves all of them.
I will be making the case that the market cap of Chainlink will be in the trillions within the next 5-10 years as well as becoming a top 3 cryptocurrency behind only Bitcoin and Ethereum.
Hybrid Smart Contracts
One of the breakthroughs for Chainlink 2.0 is the ability to create Hybrid Smart Contracts, which is significantly superior to the current smart contract infrastructure we have. So what exactly are hybrid smart contracts and what makes them so powerful? Hybrid smart contracts essentially have two parts, the on-chain smart contract that interacts with a decentralized blockchain and the off-chain section that connects to external resources such as web services, data, other blockchains, and decentralized storage. In essence, this combines on-chain and off-chain information into one ecosystem for any Dapp.
One of the main issues with smart contracts is that pure on-chain code is slow, expensive, and unable to utilize real-world data in a trustless manner. This hybrid approach allows the complex computation to be done in a trustless way off-chain which improves scalability as well.
The Decentralized Oracle Network DON
As mentioned in the previous section, there are two components to hybrid smart contracts, on-chain, and off-chain. The off-chain section is called the Decentralized Oracle Network or DON for short. DONs solve the oracle problem in the blockchain. If you have just 1 oracle giving external price information to a smart contract, it puts the entire smart contract at risk because there is no way to ensure that a node won’t provide malicious or wrong information. In short, the smart contract becomes untrustworthy and users will get rekt.
DONs are a group of oracle nodes that are financially incentivized to provide external data in an accurate manner. The independent oracle nodes collect data from as many sources as possible, aggregate it, and finally, they send the data as a validated single data point to a smart contract and the on-chain contract is executed. In addition, by concentrating and executing the transaction batch off-chain, transaction speeds are improved and gas fees are reduced at the same time. Pretty cool huh?
The next security layer is that there will be a large number of different DONs for various niches and developers have the ability to customize, choose, and integrate the DONs that are the best fit for their Dapp. This abstracts away the risk for the main chain since different groups of DONs can be used for different sections of the application, making collusion extremely difficult. Decentralization nested within decentralization is the best way to conceptualize this.
Lastly, the DONs in Chainlink 2.0 are blockchain agnostic. This means that they can be integrated into any blockchain or Dapp, whether it’s Ethereum, Solana, Tron, Binance Smart Chain, and so on. This is critical to the future value of Link for two reasons:
Chainlink does not care which platform wins the L1 smart contract race to become the main hub of economic activity in crypto. If Ethereum somehow ends up not being the number #1 smart contract platform (very unlikely) the DONs are still available for usage on whatever platform wins out. In a multichain world, Chainlink can service all of them.
This would make Chainlink the global middle layer for the entire crypto ecosystem. Link is betting on becoming the picks and shovels, not the individual gold mine. This makes it more attractive from a risk-reward perspective. I’ll let you ponder on how valuable this could be.
Fair Sequencing Services
The one main area where all smart contract platforms are centralized is how transactions are accepted and arranged by the miners. The transactions that are being sent to the miners are subjected to manipulation and frontrunning by bots. Normally a miner completes transactions based on gas fees but it’s not required to do so. Miners have the ability to insert, delete, or reorder the transactions they receive before it is submitted to a block to be mined (Blocks that have been mined can’t be reordered). Unfortunately, this issue isn’t solved by L2 rollups even if gas fees are extremely low.
Fair Sequencing Services (FSS) ensure the fair ordering of transactions and prevents front-running attacks. The DON nodes prevent the reordering of the transactions that they receive. This makes transaction submissions more decentralized and fair. When a transaction is submitted to the DON, the transaction receives a ticket that determines your place in line. No one would be able to cut in front of you. A side effect of FSS is lower gas fees from the elimination of front running.
Tokenomics
I will analyze the Link tokenomics using the supply & demand of Link tokens in relation to the three main stakeholders of Link: the corporations, the investors, and the oracle node operators.
Demand
Corporations will need Link tokens to pay the node operators. The corporations are incentivized to hold Link in order to integrate smart contracts into their business. If corporations sell their Link, then they will be unable to utilize the DON.
There will be staking node operators that will pay interest to anyone who deposits their Link. These deposits are needed as collateral so the nodes can take on certain agreements.
The corporations and investors will stake their coins in order to receive passive income on their Link tokens, which increases demand for the tokens.
Data is the oil of the internet, it will only increase in value as the internet becomes more and more integrated with our lives and big corporations understand this. In a world in which large corporations are using Chainlink on a daily basis, more Link will be bought than sold on a consistent basis.
Supply
Coins being staked on node operators will be taken out of circulation.
As demand increases, the Link token goes up in value while gaining passive income at the same time. This leads to less supply of the token since they’re locked up, causing a feedback loop in which Link tokens appreciate.
The supply is fixed at 1,000,000,000, no more can be created.
Decentralized Services Possible
I’ll quickly run through a couple of the various applications and services that are possible with hybrid smart contracts. I intend to create another article explaining this more in-depth, so it will be brief:
Proof of Reserves, which allows the wrapping of coins cross chain
Interfacing with Enterprise Systems
Decentralized Identity in a way where no sensitive data is revealed to the nodes
Under collateralized loans
DeFi with privacy features
Higher quality blockchain games
In Conclusion
Chainlink has the potential to become the entire decentralized middleware of the blockchain industry. While competitors are emerging, it is unlikely to dethrone Chainlink due to how integrated this protocol currently is across the crypto world and their first-mover advantage. Hybrid smart contracts will fix some of the current issues we are facing in blockchain today, as well as unlocking new possibilities and business models in the future. The tokenomics incentivize the key stakeholders to increase the demand of the token while decreasing the supply at the same time. A 1 trillion market cap for Link is a conservative estimate if the development and adoption of crypto continue at their current pace.
Captain BTC
(This is for educational purposes and does not constitute financial advice)
If you enjoyed this analysis, please subscribe and share for more content!
The FTX exchange has one of the lowest fees for spot and derivatives trading up to 100x leverage. Register here! https://ftx.us/#a=6881336
This is a great introductory post to Chainlink, thanks for sharing! We borrowed some of your ideas for our latest post as well!