Crypto glossary
Oracle problem
The oracle problem is the fact that blockchains cannot see off-chain data on their own, so any price, result or event they use must be trusted to someone.
A blockchain only knows what is written on it. Smart contracts that settle a loan, an insurance policy or a bet need outside facts, such as the price of ETH in dollars, a match result or the weather, and nodes cannot fetch these independently without breaking consensus. Someone has to bring the data on-chain, and the contract must trust that source.
Oracle networks try to soften the problem by aggregating many independent data providers, signing reports and staking collateral that can be slashed for misbehaviour. DeFi protocols add safeguards such as time-weighted prices, circuit breakers and multiple feeds. Even so, the oracle is often the weakest link in an otherwise decentralised application.
The problem cannot be fully eliminated, only managed. Manipulating thin markets to move a reference price has drained many lending protocols, and a compromised or lazy data provider can trigger mass liquidations. Prediction markets face a related challenge when deciding what actually happened in the real world, often relying on token-holder votes or committees.
Example
A lending protocol that reads its price from a single small DEX pool is exploited when an attacker pumps that pool with a flash loan and borrows far more than the collateral is really worth.