CoinFund’s investment thesis for API3
- For smart contracts to unleash programmable money onto the world, they need to access the world’s data as their inputs
- Oracles, the technology that is responsible for delivering data to smart contracts, is among the most critical components of blockchain infrastructure and successful oracle networks will accrue significant value
- Oracle solutions to-date have relied on third-party intermediaries which is suboptimal from a cost, efficiency, security, and stakeholder inclusiveness perspective
- By virtue of a novel architecture that increases trustlessness, decentralization, stakeholder coordination, and which lowers integration and delivery costs, API3 is likely to convert a very large market of data providers as global adoption of smart contracts and decentralized applications proceeds
One of the most transformative advances in blockchain was the implementation of Ethereum and smart contracts. Smart contracts allow money, capital, and assets to behave in a programmable manner that is simultaneously decentralized and censorship-resistant. This innovation has demonstrated serious growth. Just in the past year Decentralized Finance (DeFi) applications have grown from ~$650MM in assets put to work for borrowing, lending, and trading as of the start of 2020 to over $22.5B as of January 15th, 2021, growth of over 3300% in one year. Decentralized exchanges (DEXes) processed $25.1B in trading volume just in December 2020, with double digit monthly growth rates expected going forward. Overall, the use cases for decentralized applications are endless and represent fundamental disruption to the broad fields of finance, digital services, and marketplaces.
For smart contracts to unleash programmable money onto the world, however, they need to access the world’s data as their inputs. Almost all of this data exists “off-chain”, outside of blockchains, and is stored in centralized databases. To solve this problem, the technology known as oracles deliver the data applications need and inform their execution. Moreover, oracles need to be trustless (do not require trust), or they can manipulate the smart contracts by falsifying data, which is known as The Oracle Problem. API3 is improving upon prior architecture and is building a highly performant and commercial oracle network. CoinFund is proud to support the API3 team on their journey to develop the future of oracles.
There are a number of existing oracle networks today that operate across different blockchains. The most notable network is Chainlink, one of the earliest companies working on this problem and today the dominant solution in the market. Other approaches include Band Protocol, Tellor, and DIA. These oracle products work by having third-party intermediaries operate as nodes that connect API data sources with decentralized applications, as historically this architecture was the only practical way to deliver the data to smart contracts. This is because API providers were not able to easily connect directly to blockchains and until recently the demand for data from decentralized applications had been relatively small compared to more mature markets. This approach, however, has several notable drawbacks:
- No direct monetization for data providers. Providers do not control the delivery of data and are unable to effectively manage the monetization of their valuable data streams.
- Big integration costs. It often takes significant development work for a third-party node to connect to an API source, resulting in substantial operational work and cost.
- Inefficient delivery. The presence of third-party intermediaries who must variously coordinate to deliver correct data increases the overall cost of delivery of data to the smart contract. Furthermore, since these intermediaries need to coordinate and play consensus games, they become vulnerable to Sybil attacks introducing data security risks.
API3 solves all of these problems by focusing first and foremost on enabling connectivity for the API provider to eliminate the need for third-party intermediaries. API3 provides a simple, drop-in solution called Airnodes to data providers that allows them to connect their data directly to smart contracts. In this way, data providers again become first parties in the path of data delivery. The Airnode solution serves as a trustless on-chain proxy for APIs to interact with any smart contract on any blockchain. Data providers can feed their data to decentralized applications with minimal integration costs. Airnodes are serverless nodes and can be easily integrated using existing technologies without the need for dedicated blockchain development resources. By joining the API3 network, API providers are able to monetize their data without intermediaries. Additionally, consumers of the decentralized APIs (dAPIs) have full transparency into their data source and potential Sybil attack vectors are eliminated.
In addition to the unique architecture of Airnodes, one of the most crucial approaches of API3 to the oracle problem is its structure as a DAO (Decentralized Autonomous Organization). The API3 DAO is a community-governed organization of token holders who drive the inclusion of new data sources, manage the payment of data streams, and provide a novel insurance pool and dispute resolution mechanism to protect data consumers. The API3 DAO works as follows:
API3 token holders can stake their tokens which will grant them voting power in the API3 DAO. The funds staked in the DAO function as an insurance pool designed to compensate smart contract users in the event of an API malfunction. The stakers are compensated for this risk by receiving protocol rewards. By having an insurance pool with token holder assets, the DAO is incentivized to only integrate with high quality data providers and grow at a measured and responsible pace to prevent data issues. This serves to align token holders’ interest in growing activity levels with smart contract consumers’ need for accurate and reliable data. In addition, disputes will be resolved in Kleros Court to maintain decentralization in managing malfunctions. However, more than just the efficiency gains from improved coordination, a DAO provides a structural advantage due to its ability to align stakeholder incentives (data provider, data consumer, and token holders) and achieve broad decentralization.
The API3 team, led by Heikki Vänttinen, Burak Benligiray, Saša Milić, and André Ogle, is one of the most well-positioned teams to solve the problem of oracle networks. They have extremely deep blockchain experience, particularly working in oracle networks. Several of the key members of the API3 team formerly operated the CLC Group, which operated nodes on the Chainlink network. The team also previously built out the Honeycomb marketplace for premium APIs. Outside of their substantial experience and expertise, API3’s DAO structure allows for improved coordination and incentive design benefiting organizational scaling.
Technological advancement follows an arc of innovation and API3 represents the oracle solution on the cutting edge. At a time when blockchain usage is expanding at an incredible pace, API3 is providing a solution to bring onboard the major data providers, working with them as first parties to deliver data, while simultaneously solving for decentralization, security, and cost. Data delivery to smart contracts is one of the most foundational components of the blockchain ecosystem and the networks that do this well will become incredibly demanded and valuable. Today, the first mover network, Chainlink, has a fully diluted market capitalization of $19.8B. By contrast, API3 is currently valued just over $200MM. We expect data usage will continue to grow at an exponential pace as blockchain adoption accelerates. API3’s market leading technology and DAO based structure position it to take a dominant role in the future of oracle services and we could not be more happy to support them along the way.
 DeFi Pulse https://defipulse.com/
 API3 https://api3.org/
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API3’s architecture upgrade is the future of decentralized oracle networks was originally published in The CoinFund Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.