Oracles, which are systems that can provide external data (off-chain data) sources to Ethereum smart contracts. In the context of blockchains, an oracle is a system that can answer questions that are external to Ethereum. Ideally oracles are systems that are trustless, meaning that they do not need to be trusted because they operate on decentralized principles.
A key component of the Ethereum platform is the Ethereum Virtual Machine, with its ability to execute programs and update the state of Ethereum, constrained by consensus rules, on any node in the decentralized network. In order to maintain consensus, EVM execution must be totally deterministic and based only on the shared context of the Ethereum state and signed transactions. This has two particularly important consequences: the first is that there can be no intrinsic source of randomness for the EVM and smart contracts to work with; the second is that extrinsic data can only be introduced as the data payload of a transaction.
To understand the prohibition of a true random function in the EVM to provide randomness for smart contracts, consider the effect on attempts to achieve consensus after the execution of such a function: node A would execute the command and store 3 on behalf of the smart contract in its storage, while node B, executing the same smart contract, would store 7 instead. Thus, nodes A and B would come to different conclusions about what the resulting state should be, despite having run exactly the same code in the same context. Indeed, it could be that a different resulting state would be achieved every time that the smart contract is evaluated. As such, there would be no way for the network, with its multitude of nodes running independently around the world, to ever come to a decentralized consensus on what the resulting state should be. In practice, it would get much worse than this example very quickly, because knock-on effects, including ether transfers, would build up exponentially.
Note that pseudorandom functions, such as cryptographically secure hash functions (which are deterministic and therefore can be, and indeed are, part of the EVM), are not enough for many applications. Take a gambling game that simulates coin flips to resolve bet payouts, which needs to randomize heads or tails—a miner can gain an advantage by playing the game and only including their transactions in blocks for which they will win. So how do we get around this problem? Well, all nodes can agree on the contents of signed transactions, so extrinsic information, including sources of randomness, price information, weather forecasts, etc., can be introduced as the data part of transactions sent to the network. However, such data simply cannot be trusted, because it comes from unverifiable sources. As such, we have just deferred the problem. We use oracles to attempt to solve these problems.
Oracles, ideally, provide a trustless (or at least near-trustless) way of getting extrinsic (i.e., "real-world" or off-chain) information onto the Ethereum platform for smart contracts to use. They can also be used to relay data securely to DApp frontends directly. Oracles can therefore be thought of as a mechanism for bridging the gap between the off-chain world and smart contracts. Allowing smart contracts to enforce contractual relationships based on real-world events and data broadens their scope dramatically. However, this can also introduce external risks to Ethereum's security model. Consider a "smart will" contract that distributes assets when a person dies. This is something frequently discussed in the smart contract space, and highlights the risks of a trusted oracle. If the inheritance amount controlled by such a contract is high enough, the incentive to hack the oracle and trigger distribution of assets before the owner dies is very high.
Note that some oracles provide data that is particular to a specific private data source, such as academic certificates or government IDs. The source of such data, such as a university or government department, is fully trusted, and the truth of the data is subjective (truth is only determined by appeal to the authority of the source). Such data cannot therefore be provided trustlessly—i.e., without trusting a source—as there is no independently verifiably objective truth. As such, we include these data sources in our definition of what counts as "oracles" because they also provide a data bridge for smart contracts. The data they provide generally takes the form of attestations, such as passports or records of achievement. Attestations will become a big part of the success of blockchain platforms in the future, particularly in relation to the related issues of verifying identity or reputation, so it is important to explore how they can be served by blockchain platforms.
All oracles provide a few key functions, by definition. These include the ability to: