Citi has estimated that the number of tokenized assets will reach between $4 and $5 trillion by 2023. The World Economic predicts $10 trillion of assets to be tokenized by 2027. Boston Consulting Group, a whopping $16 trillion by 2030.
The trend is clear, the future is on-chain. But the on-chain future comes with its own set of new and unique challenges.
The largest of these? How does anyone know if the real world asset, such as real-estate, gold, and even dollars are accurately represented in value and amount by the tokens? How do we know the gold bars are truly in the vault that these “gold-backed” tokens are purported to be collateralized by?
The Oracle Problem
The “Oracle Problem” refers to a fundamental challenge in the design and operation of public blockchains and smart contracts. Specifically, that blockchain-based applications (smart contracts or decentralized applications) need to interact with and retrieve real-world data in order achieve their potential for finance automation.
Blockchains are designed to be secure, immutable, and decentralized. To accomplish these goals, blockchains are inherently isolated systems that cannot access (or be attacked) by external data or APIs directly. This creates a challenge when smart contracts need real-world information, such as market prices, weather data, or bank balances, to execute their functions. This creates a need for a reliable mechanism to bring off-chain data into the blockchain environment.
Chainlink, and other Oracle Networks solve this problem by providing secure and reliable infrastructure to fetch and deliver data from off-chain sources and make it available to on-chain smart contracts.
While a providing a core infrastructural component for blockchain-based financial systems, Oracle Network providers haven’t solved all the issues. Just to name a few:
- How does the Oracle Network know the data it’s receiving is accurate? The data is received, but what checks and validations are performed on the data? Is it even retrieving data from the issuer’s account?
- What about information that is natively “physical,” or for which the data is not retrievable via API? Oracle Networks has been to limited retrieving only natively digital data sources. Most banks do not have API functionality today. Even further behind are precious metal custodians, real-estate firms and funds.
- What if the Balance Data needed on chain is only available by aggregating balances from multiple custodians? For instance, what if the data required to show total balances and value of U.S. Treasuries backing a token is held by multiple financial institutions? Stablecoin issuers often hold funds in multiple banks. Most (if not all) Oracle Network providers are limited in their data aggregation capabilities. They can simply read one field from an API. What if the data is from multiple APIs?
While Chainlink is a powerful and growing Oracle Network that can handle many different circumstances, the role for an independent third party to perform additional services and validations on the data is desperately needed to actualize an on-chain world.
The Role of Auditors in Society
Since the time of Babylon, accountants and auditors have been relied upon to provide accurate, reliable, and complete information to serve the public interest. More recently, audited financial statements, examinations, and evaluations of internal control have been pivotal in building modern financial systems. The work of auditors has historically supported the efficient functioning of capital markets by providing investors and stakeholders with reliable information for decision making and oversight for regulators.
As the world moves “on-chain,” so too will the need for auditors, with auditors naturally evolving their practices from periodic paper reporting, to digitally native, API-enabled, Oracle-ready, and real-time reporting.
Given the historical role, expertise, and trust of auditors and accounting firms, they are in a prime position to fill the remaining gaps in the “Oracle Problem.”
Reporting ‘Trusted Data’ on Chain
The inclusion of audit and accounting firms can help solve the remaining aspects of the Oracle problem, while also creating additional benefits for the tokenized asset issuer. These benefits are numerous, with a handful noted below.
- Validate Ownership of Off-Chain Assets: Without an independent validation of the underlying “physical” or “real-world” assets, the opportunities for fraud and minting “unbacked” RWA tokens are numerous. Auditors can help confirm the off-chain components to the tokenized asset are complete, accurate, and actually owned by the issuer.
- Maintain Privacy: While APIs are a core component of the tokenization process, all information presented by the API may not want to be disclosed by the asset issuer. For example, financial institution names, account names/numbers, and account details are often desired to be keep private, along with other ancillary information. By feeding the data to an auditor prior to on-chain publishing, key private information details can be removed from the endpoint provided to the Oracle Network.
- Accountability: Without a responsible party, inaccurate information (and even self-reported) can be published on chain. With an auditor, the issuer, the regulator, and the public now have a responsible party they can lean on to provide independently reported information that’s published on chain.
- Reporting Parameters & Methodologies: APIs vary in reliability and structure. By using an independent reporting system, the auditor can build in validations and checks prior to publishing on chain. There is no need to cause a “redemption run” on the collateral if an API goes down due to technical issues.
- Data Aggregation: Since most (if not all) oracles are limited to presented 1 data point on chain, auditors (supplemented with technology) can aggregate information and present a relevant and reliable data point from disparate sources. For example, if a stablecoin issuer holds reserves at multiple bank accounts, an auditor can aggregate the reserve balances from all sources before publishing the data on-chain.
- Data Integrity Checks: While largely relying on APIs to provide information, auditors can validate the integrity, reliability and accuracy of such data sources before aggregating and/or publishing on chain. They can execute this by building in “checks” that validate a valid API response, or balance information is returning within a tolerable range on a real-time basis. They can supplement by performing periodic checks, such as transactional reconciliations and monitoring.
- Non–Digital, Off-Chain Data: While the world is moving towards APIs, many institutions do not have API capabilities. Try getting an API of your Wells Fargo or Bank of America balance! Auditors can inspect analog, off-chain data and publish the required information without needing the source data to be natively digital.
- Additional Context: A large use case of oracle networks is providing NAV balance data on-chain. But how is the NAV calculated? What is the accounting methodology to price off-market securities? Are there encumbrances on the underlying assets? Accountants and auditors can fill this role by providing additional context to the information published on chain.
- Internal Control Validation: Internal controls are important to any company’s environment. Along with publishing data on chain, auditors can inspect related controls, such as account access, to ensure the balance information is tamper-proof and fraud resistant.
Many other benefits exist from using an auditor in the “oracle equation,” such as assessing related parties, but the above points outline the core tenants of why an auditor is useful to provide trusted data to Oracle Networks.
Augmenting the Auditor
While the role for auditors seems like a perfect fit to solve the remaining challenges of the “Oracle Problem,” the accounting and audit industry has infamously gained the reputation of being slow-moving and technologically tardy.
However, this is changing, with crypto-native accounting firms, such as The Network Firm and Hash Basis, and industry-specific tools designed to enable auditors to publish off-chain data off-chain, such as LedgerLens.
Purpose-built tools such as LedgerLens enable auditors to extract electronic and analog data, review the information provided, and publish the independently retrieved information on chain via Oracle networks, such as Chainlink.
LedgerLens has dozens of pre-built integrations to global custodians that CPAs and Chartered Accountants can utilize to source data from multiple custodians, seamlessly aggregate that Balance Data, and support their clients with a single high-availability API endpoint for the Oracle Network to consume. LedgerLens also provides a rich set of tools, such as parsers, which can take data from online sources, traditional account statements, and more. CPA firms can also easily support their clients by utilizing the manual uploads feature for information from a non-digital source.
Remaining Opportunities for Progress
While auditors, augmented with purpose-built tools solve a vast majority of the problems, the future will require “on-chain” reporting standards. For example, what components of a piece of real-estate should be brought on chain and provided to the public? Address, condition of the property, the value of the property, what else? These questions, along with many others, will have to be addressed in building a transparent, immutable, and secure on-chain future.
