Adverse Selection with Oracles

Published by Mario Oettler on

Another problem oracles face stems from the principal-agent theory. If oracles put much effort into cleaning and verifying reporters’ data, they need to charge more from their customers. But if customers are not aware of the quality of an oracle, they choose the cheaper one as they calculate an average quality over all oracles.

But cheap oracles might not put as much effort into their data verification as more expensive ones. If more expensive oracles are forced out of the market, the average quality declines further and pushes the prices even lower.

This problem is known in the principal-agent theory as adverse selection.