Dynamic NFTs in Web3 (ERC-1155): Oracles as Critical Infrastructure

Dynamic NFTs contain smart contracts which may have off-chain conditions determining their execution, placing oracles at the crux of it all.

One of the most exciting — but misunderstood — concepts in the emerging Web3 space has to be non-fungible tokens (NFTs). NFTs are unique to Web3, as such novelties are composed upon the first layer (or two) of blockchains. That is, assets like NFTs may only exist after a certain threshold maturation of blockchain technology takes place in the first place.

A conceptually familiar analogy illustrates the point well enough: first came the mobile phone, then the App store, next came GPS apps like Google Maps, and then businesses like Uber were composed upon the aforementioned layers of web and mobile tech. The same phenomenon is happening at an accelerated rate in the Web3 space, meaning our ability to speculate on the future will in retrospect likely be found lacking in imagination.

From digital to physical NFTs, and now to dynamic NFTs, things are evolving quickly. Not only are companies using NFTs to keep track of limited edition items, but also exploring the tokenization of real estate through dynamic and fractionally-owned NFTs. As such, their potential properties and future composability are still actively being discovered.

Not only are dynamic NFTs fascinating, but their technology unlocks potential use cases which will produce new economic incentives, allowing for investment in spaces which may have heretofore been economically impractical. This could include lending services, financial access for impoverished nations, or even monetizing the creativity of digital entrepreneurs.

Dynamic NFTs & Verifiable Randomness

NFTs, also known as ERC721 tokens, are assets whose main characteristics are uniqueness coupled with the property of being non-fungible, hence the name. A decent analogy would be to compare NFTs to one-of-a-kind pieces of fine art. Some creators are famous; their works are sought after at sometimes exorbitant prices, and they are not divisible into smaller uniform quantities.

However, for our analogy to maintain its integrity with NFTs, we must imagine that there was also an immutable and shared ledger of fine art ownership. Furthermore, through our hypothetical fine art ledger, the art itself, its ownership, and its history could be traced with precision along with its current price and spot price at each transfer of ownership. This is the case with NFTs on the blockchain.

Though NFT marketplaces have seemingly sprung up everywhere, the real attention-grabbing headlines for many has been the hefty price tag some have paid for what amounts to a fancy JPEG file. That will begin to change quickly, as NFT offerings become more nuanced than before, offering conditional smart contracts embedded within their metadata.

Previously, NFTs referred to the static variety, which had special properties which did not change. Now, dynamic NFTs have deterministic smart contracts which use off-chain data, relying on oracles to fetch and validate the relevant data and keep it constantly refreshed. The NFT’s dynamic properties may be upgraded, decay, or change over time.

Aside from being digital art tracked on blockchain ledgers, these dynamic NFTs can also be used to connect content creators, famous athletes, and media personalities with the communities which consume their content. The community-based NFT framework unveils a more practical application for the technology, as it incentivizes participation and membership in digital communities and events.

For instance, Bored Ape Yacht Club NFTs regularly sell for $250,000 and often much higher, with ownership of one of the 10,000 unique apes granting memberships to physical events and parties like Ape Fest or its VIP charity dinner. NFTs could also grant the owner special access to areas of the Metaverse, like backstage passes to a virtual concert. Our creativity is the only limit to what dynamic NFTs can do. 

For instance, creators could transform their artwork into NFTs which may function similar to a membership card to access paywall content, or perhaps a discount promo code when making a purchase. By collecting a set of NFTs, users could unlock bonuses, exclusive material, VIP access, or even a physical meeting with their favorite content creators. Rather than simply being bought and sold on secondary markets, these special characteristics embedded within NFTs elevate the value of the technology beyond what was once considered possible. 

In order for all of this to work, dynamic NFTs make use of verifiable random functions (VRFs) to assign ‘winners.’ In cryptography, VRFs provide proof that outputs were indeed generated randomly from sets of inputs. It is essentially a lottery drawing, but with cryptographic proof that winners were chosen fairly. The VRF typically works by taking user-supplied seed inputs from participants, sometimes requiring a small fee paid in crypto, and then generating a verifiable pseudorandom public-key output. The result is written on-chain, using the user-supplied seed inputs to mint the NFT to the user’s wallet address.

Dynamic NFTs are embedded with benefit-granting attributes directed at their token holders, and can even gain new attributes over time.

Oracles are collections of nodes which fetch and validate external data for Web3 smart contracts, like the ones used by dynamic NFTs. They are essentially the communication channels between blockchains and off-chain data sources. Since blockchains are closed systems which operate and execute smart contracts based on data from their native ledgers, they are unable to do business with off-chain assets without oracles.  Thus, oracles are absolutely crucial for NFTs to become ubiquitous.

Oracles track spot prices, report world events, and even allow for off-chain assets to be exchanged in tokenized forms, increasing the variety of crypto assets available to trade, and compounding the economic potential of Web3 as well. This makes oracles incredibly important to the proper functionality of any protocol, as they require accurate data at all times.

If a blockchain’s oracles are compromised, so is the protocol and its smart contracts; this makes oracles into potential single points of failure. Since smart contracts are deterministic and mostly irreversible, they rely heavily on the integrity of the data oracles provide. After all, one of the main advantages of smart contracts is their aversion to centralization and counterparty risks.

Though oracles help enable trustless smart contracts to be executed, failure to decentralize their operation will lead to node corruption, price manipulation, or network attacks on a long enough timeline. This threat is known as the Oracle Problem, and it has made the preservation of privacy, security, and decentralization a key part of any Web3 discussion. If, for example, an oracle provider gave faulty or stale data to a DeFi protocol, the resulting spot price deviations could wreak financial havoc on its users. 

Considering that oracles power DEXs, synthetic assets, stablecoins, NFTs, and more, it is no surprise that developers are rushing to secure a high throughput, decentralized and tamper-proof oracle solution. Oracle providers such as Chainlink and Band still face criticisms over validator centralization or network scalability issues. Thus, oracle providers and the Web3 protocols they interact with still face challenges if they are to become ubiquitous financial tools.

Dynamic NFTs create a fun and exciting new landscape for content creators and their fans to interact both socially and financially. 

Real estate is an obvious area for dynamic NFTs to be useful, as owners might collect fees from any revenue the property collects over time. For instance, buying a real estate dynamic NFT might convey time-share rights to individuals for certain dates of each year. Other stipulations may be embedded into the NFT to include financial payouts during specific time periods, like when other individuals use the property. The dynamic aspects of the NFTs may also have expiration dates, meaning that the special properties granted to token holders would eventually cease, meaning its final form would more resemble a digital collector’s item.  

Finally, skill trees, commonly found in gaming, can also be applied to education and credentialing programs. In gaming, players are incentivized to complete challenges in order to unlock content, level up their avatars, or gain in fiscal or practical value in some way. In the case of education and credentialing, dynamic NFTs might be assigned to individual students, with transcripts being recorded on digital ledgers and achievements being unlocked by deterministic smart contracts. Off-chain data, like student attendance and test scores, will be tracked and verified by oracles before it becomes immutable on the blockchain. This sort of credentialing will reduce fraud and as well as provide a frictionless and efficient way to demonstrate one’s given skillset on a university or job application.