Deep Dive: Chainlink in 2024 w/ Sergey Nazarov

27:26But now you don't have to be a John Paulson or a very limited number of people that were able to go down to this level of depth and understanding that within banks, only a few people had like CDO managers. Now you kind of arrive at a world where everybody can analyze that, just like everybody can analyze a DeFi protocol and see what its solvency is. And everyone can look at a blockchain transaction on a Block Explorer. So I think it's an immediately solvable problem. And another good example is the default of banks. So the thing that I always ask people to think about is, imagine if you knew every single piece of information about the health and progress and solvency of your bank or asset management partner that the CEO of that bank knows.

28:20Imagine if you had direct access to everything going on there. You didn't need to wait for accounting audits. You wouldn't need to wait for rating agencies to make decisions for you. You would just have the information. You would be able to see, oh, wow, this week, the bank underwrote a lot of really high risk debt. That's not good. Let me monitor that. And maybe if that keeps happening for a second week, I'll see what I want to do with my money in there. Instead of waiting 10 years and then finding out, oh, the bank underwrote huge amounts of high-risk debt, nobody seems to have known about that very clearly.

28:58Guess what? We can't access the money in the bank. Time for the U.S. government to print more money to save the bank and create an artificial tax on everyone through inflation. So it's a very, very significant change just by the market being able to access information. and the market is able to access information because the smart contract is this kind of agent, this impartial agent, this box that can't be manipulated, that you can put all the information in, but no one can manipulate it. And so everyone can trust it. And this is the thing that hasn't existed. And this is the thing that people have continued to even now still confuse between what blockchain technology they think it is and what it actually is.

29:46What they think it is, is it's some kind of weird oddity. What it really is, is the way that all transactions, all data about value, all issuance, all management of value, whether that's insurance-related value, whether that's equity-related value, whether that's commodity-related value, real estate-related value, will be transacted because it's just a superior way to do that. And this is the very big shift that I see more and more people understanding, but still is not fully understood because, frankly, as I dove into the kind of capital markets, trad fi, global financial system rabbit hole, and I started understanding step by step every single step that happens in a transaction, for example, for a delivery versus payment transaction, all the settlement steps, all the payment steps, all the reconciliations, all the things that need to happen.

30:42for a transaction to successfully conclude. I mean, you find an unbelievable amount of stuff that is just completely and totally solved when you can put a piece of data on a blockchain and prove that something happened. And so the blockchain is the mechanism where that data goes, and the Oracle network is the thing that does the proving that it happened. Sergey, aren't you still, though, at the mercy of the data that comes into the system? Is that a question that you guys have wrestled with? How do you get the data into the system? Even if you have this cryptographically secure way based on mathematics and physics to secure the information once it gets into the system, how do you get that last mile of whether or not I've bought 12 houses in the last six months or not, whether I have employment verification or not?

31:33How do you control that component of the system? And have you thought about that? Sure. So you make it more transparent as to where the data comes from and how it's aggregated into a final answer is the answer, is the basic answer to your question. So we have a proof of reserves system within the Chainlink set of protocols and standards. And the proof of reserve systems shows where the data comes from. Now, the data can come from multiple APIs, and then it can be aggregated to get you to a final answer, or it could come from one API. But that one API, you know who it is. And usually the way people construct this is it's someone that doesn't have a vested interest in whether that financial product works out.

32:17Their job is just to provide the data about whether the gold is there, whether the financial product is actually backed by something. So the deeper answer to your question is that Chainlink is a framework for constructing consensus around all of these things that happen outside of a blockchain. So you and me could get together and say, we need three data sources in order for us to consider a piece of data as authoritative for the purposes of our transaction. And here are the three data sources we want to use. And then we compose those data sources into an Oracle network with some nodes. And we know who the nodes are because the nodes were also selected.

32:58And then we can show that to a third person that wants to come and participate in buying that asset, trading it, dealing with it. Because now they know both the smart contract code and they know what's triggering the asset. And you actually need to know both. And so as the value in the asset grows, as the value in DeFi protocols grow, what we often see is the amount of oracles in an Oracle network increasing and the amount of data providers increasing because the value they control has grown to become greater as well. And so this is also a dimension of what the Chainlink protocol and set of standards seeks to solve is to give developers and people who compose these systems an easy and simple way to define what reliable data is and to connect all of the necessary different data sources and to aggregate the data in a transparent way that proves to everybody that the data is also resistant to a certain level of manipulation.

33:59manipulation. And how long do you think that process takes? You have to create the standards, you have to get the end software built to suck in the data at the last mile. How long of a process do you think that's going to be before we're able to get reliable data on a blockchain that's aggregated and has sufficient decentralization to enable the type of ability to authenticate the data that you're talking about. Well, that's what Chainlink has already done for DeFi. And so far on public chains, there's over 12 trillion US dollars in transaction value that's been enabled through that process and some cross-chain and some other things.

34:40So I would say in certain categories of applications, like certain DeFi categories, that already exists. And that's one of the... I guess the distinction is that for DeFi, it's already native on-chain, right? So the data begins on-chain with DeFi, and then you're able to aggregate it centrally in a decentralized way in a way that you wouldn't be able to do with something like employment data. How do you get that data onto the chain? Nope. For data, data doesn't begin on-chain. The data begins off-chain. And then the Chainlink system aggregates the data and proves with a sufficient amount of data sources and nodes that it meets certain reliability and manipulation-resistant standards.

35:21The data that people rely on that's generated on-chain, like DEX data, is actually the thing that's most commonly manipulated when people want to manipulate a DeFi protocol's prices or something like that in the course of something like a flash loan attack. So this is already something that is solved on certain dimensions of data by the Chainlink ecosystem. And now the challenge is to extend both the amount of data sets that can be aggregated in this reliable way and to apply other capabilities to smart contracts, like the ability to interact with AI models, the ability to go across chains, the ability to interact with various computations that don't exist on a chain, but a smart contract.

36:06needs to do something more valuable, like interact with the Monte Carlo simulation as a determining factor for a trade or something. So there's all these off-chain activities that need to be made reliable in order for them to be combined into a smart contract. One of those is the data aggregation activity, which Chainlink, this is what Chainlink initially saw through the invention of decentralized Oracle networks, dons. And now that's being expanded to more and more categories of computation, basically off-chain computation. So not on-chain computation. On-chain computation is consensus around a ledger, the existence of a token, the movement of a token, those kinds of basic activities in certain state machines, state changes, defining how the token works.

36:57Like, if I receive this price from an Oracle network, I can give you this much yield or something like that. But the next stage of pretty much all advanced smart contract applications, including real world assets, require decentralized Oracle networks to provide them pieces of data, provide them connections to other chains in order to transact against the counterparties they want to buy the asset and give them various computations like access to AI models and all kinds of other off-chain computing systems and services. This is what Chainlink does across chains and across use cases. It fundamentally solves this problem of how do I interact with off-chain systems in a way that approaches the reliability of on-chain systems.

37:46And that's why it's a very unique and useful system. You began your answer by saying that DeFi data does not natively begin on-chain. Explain what you mean by that.

38:01I mean, the price data driving a lot of DeFi is generated off-chain to achieve a global price of a cryptocurrency. To achieve the global price of a cryptocurrency, for example, you have hundreds of different exchanges. Those hundreds of exchanges are the ones that right now determine the price. The price of cryptocurrencies right now, with cryptocurrencies as just one example, is not determined on-chain. It is determined by the trading activity of various off-chain exchanges. And so the price inherently comes into existence off-chain. Then it is aggregated by data providers and data aggregators.

38:41And then it is eventually fed into a chain link oracle networks that aggregate the data from those data providers into a final answer that powers DeFi. The only price data that's generated on chain is really DEX and PERP data. And DEX and PERP data is relatively straightforward to manipulate, which is why you hear constantly about flash loan attacks. So that's just for crypto data. If you take any other asset that isn't a crypto asset, a cryptocurrency, like a commodity or equity or something else, then that data right now, by definition almost, is generated off-chain. Because trading activity and that price discovery activity doesn't happen on blockchains.

39:27It happens in various off-chain centralized systems, exchanges, and so on. So the whole big thing that Chainlink initially solved was getting off-chain data reliably on-chain so that DeFi protocols could be constructed around it, both derivatives protocols, lending protocols, all kinds of protocols that couldn't exist without highly reliable data coming from the off-chain world where it's generated initially for use in the on-chain DeFi. contract. This is why Chainlink powers the majority of DeFi and why DeFi was a sub$100 million total value industry when Chainlink started with, I would say, a handful of teams.

40:15We're talking like tens of teams and 20, 30 something teams that were like real teams trying to do something. And why would Chainlink powering the majority of DeFi grew to an over$200 billion industry with thousands of teams. It's because this problem was an unlock, just like smart contracts, composable, editable smart contracts were an unlock created by Ethereum. So that's why Chainlink is so widely used, because just like Ethereum invented these highly editable Solidity smart contracts, Chainlink invented and originated kind of configurable Oracle networks. There are over a thousand Chainlink Oracle networks on production at this point.

41:01I mean, it's fluctuated about a thousand or less, a little more, depending on which ones get spun up. If you count testnet and staging, there's thousands of these Oracle networks for all the different variations. These are the dons that you talked about, the idea that these networks are... Yeah, so decentralized Oracle networks are the kind of unique idea and invention that has now worked within in the Chainlink ecosystem. So the first decentralized Oracle networks were generated by Chainlink. They gave rise to the first successful working DeFi protocols because a DeFi protocol is basically a set of on-chain contractual conditions and it's an Oracle network that proves those conditions happen.

41:44If you don't have both of those things, you can't make it work. You need both. And so there were a bunch of people trying to make DeFi work because it's a logical idea. but then they were always stuck on... Well, additionally, they were stuck on how to make a smart contract work, and then Ethereum solved that problem. And then they were stuck on the problem of how to get the proof that something happened to the contract for it to resolve. And that's what Chainlink and Decentralized Oracle Networks solved. So that's what we initially solved. But now all of that has evolved far beyond just data.

42:20It's evolved into cross-chain connectivity, connectivity to computations like AI, all these other things. Basically, anything that a smart contract needs to do a valuable operation, an Oracle network should be able to make more reliable so that the smart contract can rely on that input. And the Oracle networks can also act as agents on behalf of the smart contract to affect things like traditional payments or other off-chain events. So the analogy that sometimes I hear used is that smart contracts without Oracle networks are like cities without electricity. Everything is there, but it won't necessarily work unless you give it electricity.

43:07And the Oracle networks give it all of this connectivity and all of this additional computation to allow the smart contracts to go beyond on-chain operations, which are relatively limited. For example, we in the Chainlink universe of standards and protocols have an automation solution because smart contracts do not know what time it is. They don't know whether it's 9 a.m. and the market is open or it's 5 p.m. and the market is closed. The only thing a smart contract actually knows is what block they are on. They don't have a sense of time. And so you need something like automation basically to trigger the smart contract to do its operations.

43:47And even that, you need an Oracle network. And if that Oracle network is not reliable, then the smart contract doesn't get triggered, which leads to all kinds of attack vectors where you can start to manipulate. And the reason you need an Oracle network for something like time is because if you want to truly decentralize this and you want to have multiple sources that are difficult to intercept or spoof or have an attack vector against, the more widely distributed those sources are, the more decentralized, the more robust and stable and tamper resistant the system becomes. Right. That's right.

44:19So decentralized Oracle networks have a configurable way to be decentralized. So you could make a decentralized Oracle network out of seven chain link nodes, 16 chain link nodes, 21 chain link nodes. There's a big gamut of different numbers of nodes. And you can also configure the amount of data sources going into those networks. This is one of the big challenges of making decentralized infrastructure, is that you have to make a system that can be composed of various independent parties coming to the same conclusion and then aggregating their results in a way that none of them can tamper with it.

44:57And so this is what's decentralized. As you get greater decentralization, how does that affect things like speed, latency, throughput, etc.?

45:08It depends really on who the node operators are, what resources they have, what investments they've made in infrastructure themselves, the quality and speed of their connections. and all of that can also be configured. So generally speaking, the more that people need to come to consensus, usually the more of a performance that you take, but up to certain levels of decentralization that provide what I feel and what other people feel are a sufficiently high level of security and tamper-proofness, you can achieve very fast speeds, very high levels of reliability and so on. It really boils down to what the node operators are willing to run and how much they're willing to spend in terms of their time and effort and uptime and all this type of stuff.

45:56But it's a solvable problem. At the speeds necessary to handle trading, for example. Sure. Depends, right? There's all kinds of different levels of trading. If you're talking about high-frequency Forex trading, that high-frequency Forex trading in the blockchain world would happen on a blockchain. So your first problem wouldn't be the speed of the Oracle network. Your first problem would be generating a trading environment that can even execute those trades at that level of speed that's needed by all of those participants if they're in different places. Right now, in all of our experience, the Oracle networks are not the bottleneck.

46:37it is pretty much always the blockchain technology that's the bottleneck in terms of the speed at which it can operate and provide its computations. So right now, we're not in a world where the Oracle networks are the bottleneck. We're in a world where the blockchain's technology confirmation times, you need to wait six blocks until you have finality. You need to wait this long until you can consider the transaction truly reliable. All of those kind of probabilistic transaction reorg-related risks right now don't really make the Oracle networks the stopping point. It's always the blockchain, pretty much.

47:19Really interesting. Talk a little about how Chainlink works from the perspective of tokenomics, what the role of the token is in the ecosystem. Sure. Yeah, so the link token is there for utility for people to purchase the services, the secure Oracle networks and how they're utilized. And it basically enables people to gain access to all the capabilities in the system, pay for them just like you would pay in Ether for Ethereum computations and so on. And that's kind of the dynamic. So it's a pretty direct dynamic. So essentially, it's purchasing utility processing power throughput in the network to actually perform the transaction of validation of oracles.

48:01Yeah, yeah. Just like in Ethereum, you get some Ether, you pay for the transaction, you say, hey, I wanted this computation. In Chainlink Oracle Networks, you get Link, you pay for the necessary computations, whether it's a data-related computation or some other automation computation or a cross-chain event or whatever set of events. That's what it's primarily used for right now, yes. So we've talked a lot about the actual nature of the infrastructure, how it functions. Talk a little bit about what folks who are not following this nearly as closely as you are should be looking for. What do you expect is going to happen next?

48:35What will be some signals that this adoption is becoming more widespread?

48:43I think people should pay attention to the real world asset trend. I think they should look for how the real-world asset trend interacts with the DeFi industry because I think there's a lot of really big potential there. I think that's a market that will have a lot of value from what the real-world asset folks are doing and that those two worlds can kind of interact in very valuable ways that benefit both of them and allow both of them to grow. So I think that in and of itself is a trend encapsulated within the public blockchain world itself, right? So that can happen without any bank adoption or financial market infrastructure decisions or anything.

49:21Then you have the parallel world of bank chains, private chains, asset managers, financial market infrastructures, the global financial system, traditional systems that have hundreds of trillions of dollars in value on them. And in that world, I would look at what's going to production, how many systems are in production, how many of them are actually doing transactions, How many of them are doing greater numbers of transactions, more volume in those systems? And interestingly, how many of those systems might be interoperating with each other over a system like CCIP that would allow them to do valuable operations and transactions across multiple private bank chains and blockchains owned by institutions?

50:04And then you kind of arrive at a world where you'd continue to have these two parallel worlds of a public blockchain world where there's a lot of permissionless innovation and there's a lot of great kind of unique things happening, both in the DeFi world, the real world asset world, maybe the GameFi world. That can, I think, be a very interesting place if people really get that right and have a sustainable economics and ecosystem. So you have the public chain world kind of growing in the DeFi, RWA, and GameFi categories. Then you have the traditional world growing. And then the collision of those two worlds is also going to be a very big deal.

50:44Because both of those worlds are fundamentally involved in the same thing. They're fundamentally involved in doing transactions. They're fundamentally involved in doing delivery versus payment. sending a form of payment for an asset of some kind. They're both generating assets. They're both representing user accounts with purchasing power that want access to more assets and want to put those assets in yield-bearing financial products and instruments. So those two worlds, in my opinion, will eventually collide. And that collision of those two worlds will allow them both to grow. It'll make the public chain RWA DeFi world grow significantly because of all the value in the institutional world.

51:33And once that institutional world value can both efficiently, securely, and in a legally compliant way flow into the public chains, that's kind of like what the ETFs are. The ETFs are the first very early version, or like not the first, maybe the second, because you had some stuff before the ETFs that did slightly similar things, but with more friction and more problems. But basically, the traditional system will feed the public blockchain system value, and the public blockchain system will feed extremely innovative, but high-risk assets and applications to the traditional financial system. But the traditional financial system as a significant percentage of its population that wants the most cutting-edge, sometimes high-risk assets and yield-bearing products and instruments.

52:25So these two worlds are really kind of made for each other. They just don't seem that way because they can't or don't transact with each other yet. But they'll both be growing in their own way. and then eventually they'll merge into one, what we call, Internet of Contracts. And it is this Internet of Contracts that we're basically in the process of building the global standards for, whether those are standards around data, whether they're standards around cross-chain connectivity, whether they're standards around how to do off-chain computation, whether they're standards about how to define AI interactions with smart contracts.

53:01All of those things require shared standards so that when a Web3 DeFi protocol wants to interact with a private chain bank user, they know how to do that, right? They can agree on a price. They can send the stablecoin and receive the asset. They can verify that this is allowed or is a good idea against an AI response. They can verify that it's legally compliant against the CSD signature or something like that. So basically, these two worlds colliding, I think will be the biggest signal. Sergey, it's always a pleasure to have you on the show. I always enjoy these conversations. Final thoughts, key takeaways that you'd like to leave our viewers and our listeners with?

53:40I think the next five years are going to be very interesting for all of us, not just in the blockchain world, but just in the world generally. I think our industry has a very big role to play because if the world becomes more unstable, the system that provides reliable stability is going to be very important. And I think the blockchain industry has matured to the place where it can secure very large amounts of value. And it's going to now mature to the place where it can do that in an efficient and legally compliant way. And if the traditional world has problems, whatever form they might take, then I think the nontraditional crypto guarantees will be more attractive than more traditional systems guarantees.

54:33And that is another thing that I think can kick off a big migration. But all in all, it's going to be very interesting. And I think our industry is going to create the reliability that the world needs to continue to operate. And I think that's a very useful and important thing. You know, Sergey, I think one of our first conversations here on Real Vision, you talked about this notion of verifying things with physics and mathematics rather than trust, rather than brand identity. and it is a major paradigm shift in the way that the world works. And it's going to just be an incredible time to watch.

55:05Thank you so much for joining us. It's my pleasure. Thank you. We hope you enjoyed this episode. At Real Vision, we arm you with expert knowledge, time-efficient tools, and a powerful network to help you succeed on your financial journey. Get a taste of financial freedom with our free offer at realvision.com forward slash free. That's realvision.com forward slash free.

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