Cryptocurrencies are powered by blockchain, software that runs on a decentralized network of computers, which allows you to validate, record and protect transaction data from attacks. Platforms like Ethereum extend that functionality, allowing developers to create self-executing computer programs on the blockchain.
These programs are called smart contracts and form the heart of decentralized finance applications (DeFi), products that allow users to access financial services without going through a bank or other intermediary. And by eliminating the middleman, DeFi applications have the potential to make the financial system more accessible, less distorted and cheaper.
Ethereum is currently the largest DeFi ecosystem, with $ 175 billion locked (invested) in various DeFi products. And with a market value of $ 518 billion, it is also the second most valuable cryptocurrency in the world. But while Ethereum still looks like a smart investment, it may offer fewer long-term benefits than some smaller cryptocurrencies. For example, Chainlink (quotation LINK) has a market value of just $ 13 billion, but plays a vital role in DeFi. Here's what you should know.
Making smart contracts more useful
Chainlink is a decentralized Oracle network powered by LINK, a token built on the Ethereum blockchain. Oracles are entities (e.g. connected people and devices) that bring real world data (off-chain) to the blockchain. To illustrate why this is important, consider the following DeFi products.
Compound is an Ethereum-based DeFi protocol that allows users to earn interest by lending cryptocurrency. For example, you could now earn an annualized 3,22% by supplying the USD Coin cryptocurrency to Compound. But the platform supports several other cryptocurrencies, and the interest rate on each asset is algorithmically set based on supply and demand. In other words, the Ethereum blockchain contains all the data needed to power the Compound protocol.
But some DeFi products require real-world data
For example, consider a DeFi platform that allows users to bet on sporting events or purchase tokenized assets (e.g., artwork, real estate). Each of these smart contracts requires data not available on the blockchain, in particular the outcome of the sporting event and the current market value of the assets. Chainlink is the bridge that makes these smart contracts possible, and LINK is the token that makes the whole system work.
Specifically, the Chainlink platform allows oracles (real-world data providers) to bid on requests from buyers (real-world data buyers). To join the network, oracles must first target LINK tokens, a prerequisite that keeps them honest and ensures their accuracy. Once the job is complete, buyers compensate Chainlink's oracles with LINK tokens.
Likewise, oracles can provide the same function in reverse, bringing on-chain data to real-world applications. For example, imagine you are renting a vacation home and the rental contract is a smart contract; once payment is made on the blockchain, the system could signal an Internet of Things (IoT) device to unlock the door of your rented home.
The investment thesis
So? As DeFi products become more popular, oracles should see an increase in demand. And Chainlink is the most popular Oracle network, providing data to smart contracts worth more than $ 75 billion across multiple blockchains.
This popularity should be a boon to the platform, and as more contracts are created to interact with Chainlink's oracles, smart contract operators will need to purchase more LINKS to compensate the oracles for their service, increasing the token price. This is why this cryptocurrency looks like a smart long-term investment.