What is an Oracle?

An oracle is a bridge between the blockchain and the real world. They act as on-chain APIs you can query to get information into your smart contracts. This could be anything from price information to weather reports. Oracles can also be bi-directional, used to "send" data out to the real world.

Why are they needed?

With a blockchain like Ethereum, you need every node in the network to replay every transaction and end up with the same result, guaranteed. APIs introduce potentially variable data. If you were sending ETH based on an agreed $USD value using a price API, the query would return a different result from one day to the next. Not to mention, the API could be hacked or deprecated. If this happens, the nodes in the network wouldn't be able to agree on Ethereum's current state, effectively breaking consensus.

Oracles solve this problem by posting the data on the blockchain. So any node replaying the transaction will use the same immutable data that's posted for all to see. To do this, an oracle is typically made up of a smart contract and some off-chain components that can query APIs, then periodically send transactions to update the smart contract's data.