In his most recent publication, Jesus Rodriguez discussed a major remaining challenge for security tokens: the integration of off-chain data. Rodriguez holds that a potential solution centers around oracles, and perhaps something along the lines of a Know Your Oracle (KYO) protocol.
The Integration of Off-Chain Data for Security Tokens Explained
The most critical aspect of security tokens is the introduction of compliance to blockchain-based assets.
Since security tokens feature the tokenization of real-world assets, compliance undoubtedly involves off-chain data, meaning data which is external to a blockchain network.
Oracles are the key component responsible for interacting with external data while still maintaining the integrity of a blockchain. According to Rodriguez, the development of oracles will be crucial for the successful implementation of security tokens:
“Incorporating access to off-chain information within smart contracts [via oracles] is, in my opinion, one of the key capabilities needed to streamline the adoption of blockchain platforms. In the context of security tokens, the oracle challenge is greatly magnified as external information plays a fundamental role in the lifecycle of many crypto-securities.”
To provide the proper information disclosures needed for the compliant trade of assets, security tokens require sources of external data just as much as they need anything else. While such sources are a remaining challenge for security tokens, Rodriguez has provided three fundamental categories of oracles which he says can be incredibly valuable in the near future.
- Compliance Oracles: There are numerous instances where the transfer of tokenized securities requires some type of external approval which has yet to be implemented via smart contracts. Compliance oracles could therefore serve as an intermediary, by interacting with those external sources and relaying their approval or denial on-chain.
- Disclosure Oracles: Certain assets can feature ratings from external parties. These ratings need to be updated as new information becomes available concerning a given asset. This new rating needs to be reflected in a digital asset’s smart contract to prevent information asymmetry and to ensure fair trading. Disclosure oracles can source such information from reputable sources and update the asset’s smart contract accordingly.
- Programmable Logic Oracles: Here, oracles can be programmed with certain behavior. As a result, specific on-chain behavior of a security token can prompt off-chain actions.
How a Know Your Oracle (KYO) Protocol Could Incorporate Off-Chain Data
The most common form of compliance for digital assets includes verification of token holder identity. Typically, this is done through Know Your Customer (KYC) verification.
Rodriguez playfully introduced the concept of Know Your Oracle (KYO). A KYO protocol could match approved sources of external data which would influence the trading price of a security token, and then associate such sources with appropriate blockchain addresses.
In this way, information disclosures from external sources can be reflected in a smart contract, where the KYO protocol can provide the disclosures to a whitelist of approved oracle addresses. It may sound complicated, but Rodriguez says the idea would be quite simple to implement.
While security tokens are continuing to pick up the pace— including an SEC-approved security token trading platform in the US, tokenized real estate, investment funds, REITs, and more— certain challenges continue to exist.
According to Rodriguez, the integration of off-chain data is near the top of a list of challenges faced by the security token industry. Oracles however, if applied in the right manner, could make that list just a little bit shorter.
What do you think of Oracles solving the problem of incorporating off-chain data? How likely is the proposal to see implementation? Let us know what you think in the comments section below.
Image courtesy of QCon New York.