Smart Contract

What Is a Smart Contract?

A smart contract is a piece of software that lives on a blockchain and runs according to rules written into its code. The "contract" in the name refers to an agreement between parties, such as a payment that is released when a delivery is confirmed. The "smart" part means the agreement is carried out by computer code rather than by lawyers, banks or other intermediaries. The term was popularized by computer scientist Nick Szabo in the 1990s, and it became practical once blockchain platforms such as Ethereum made it possible to run such code on a shared, decentralized network.

How It Works

A smart contract is written in a programming language, deployed to a blockchain, and given a fixed address that anyone can interact with. Users send transactions to the contract, which triggers its code. The code checks the conditions it was written to check, and if they are met, it performs the specified action, such as moving cryptocurrency between accounts, issuing a token or recording ownership. Because the blockchain records every transaction and validators on the network confirm them, the outcome is generally the same for everyone who checks it. Once deployed, most smart contracts cannot be easily changed, although some are designed with upgrade mechanisms.

Example and Uses

A simple example is an escrow arrangement. A buyer sends funds to a contract, the seller ships the goods, and the contract releases the payment to the seller once a confirmation is received. Smart contracts are also the foundation of decentralized finance (DeFi) applications, which offer lending, trading and other financial services without a traditional institution in the middle. They are also used to create and manage non-fungible tokens (NFTs) and to automate payouts in other settings.

Risks and Limitations

Because the code is final once deployed, bugs or design flaws can be costly. Attackers have exploited vulnerabilities in smart contracts to steal large sums, and errors in the code may not be fixable without special upgrade provisions. The code also cannot see information outside the blockchain on its own, so it typically relies on external data feeds called oracles. Smart contracts are a technical tool, and their legal status as binding agreements is still evolving across jurisdictions.