What Are Smart Contracts?

BeginnerJan 11, 2023
Decentralized software applications that work using blockchain technology.
What Are Smart Contracts?

Smart contracts are software applications that utilize blockchain technology. Smart contracts can be used to issue new cryptocurrency tokens, operate distributed autonomous organizations (DAOs), and enforce other financial and legal agreements.

Smart contracts have many advantages, including features that make them transparent, efficient, and secure. Keep reading to learn more about smart contracts, how they operate, how you may use them in the future and many more.

What Is a Smart Contract?

A smart contract is computer code, often hosted by the Ethereum blockchain, that can store and automatically execute a financial or legal agreement. A smart contract may be a simple bit of computer code or a lengthy, detailed set of instructions comprising up to 24KB of information.
Since every smart contract has a different purpose and programmer, each smart contract may look very different.
Smart contracts play a key role in the operation of DAOs, which are blockchain-based organizations that operate fully independently without being governed or controlled by any centralized group. While DAOs can exist for a variety of purposes, one example of a DAO that uses smart contracts is the blockchain platform MakerDAO. This DAO, which supports the DAI stable coin, uses the MKR token to facilitate decentralized governance of the MakerDAO platform.

How Do Smart Contracts Work?

Like cryptocurrencies, smart contracts operate using blockchain technology. Smart contracts, by relying on if-this-then-that logic, are akin to digital vending machines. Let’s delve into how smart contracts work:

  • A Smart contract is created: Anyone with computer programming knowledge can create the code for a smart contract. The programmer defines the rules for how the smart contract functions and manages future transactions.

  • The Smart contract is added to the blockchain: The smart contract is uploaded to the blockchain, similar to how cryptocurrency transactions are recorded. This typically requires paying a fee, such as the Ethereum gas fee, to use the blockchain network.

  • The Smart contract is confirmed: Once the block containing the smart contract is confirmed, the smart contract is live and publicly viewable through a blockchain explorer. The smart contract is open, pending the conditions of the contract being met.

  • The Smart contract is executed: When all of the terms of the smart contract are satisfied, the contract executes in accordance with its original programming. Completed smart contracts on a blockchain are irreversible and ca not be changed.

Smart Contract Applications

Smart contracts can have many different applications, including:

  1. Financial agreements and financial services: Smart contracts can be used to clear and settle securities trades, and can manage financial documentation.

  2. Legal contracts: Smart contracts can automatically enforce legal agreements by facilitating the payment of funds upon certain triggering events or imposing financial penalties if certain conditions are not satisfied.

  3. Real estate transactions: Smart contracts can be used to automate the buying and selling of property, which can help to reduce the time and costs associated with traditional real estate transactions.

  4. DAO governance: Decentralized autonomous organizations rely on smart contracts to facilitate broad-based decision-making.

  5. Digital Identity: Smart Contracts can be used to provide a secure, decentralized, and tamper-proof way of storing, sharing, and verifying personal identity information.

  6. Health care management: Smart contracts can be used to automate the sharing of medical records and the management of medical treatments, which can help to improve the efficiency of the healthcare system and increase patient privacy.

  7. Supply chain documentation: Smart contracts can be used to automate the tracking of goods and materials as they move through the supply chain. This can help to increase transparency, reduce errors, and improve efficiency in the supply chain.

  8. Public-sector record keeping: Governments can use smart contracts to automate how public records are collected and maintained.

  9. Voting: Elections can be conducted using smart contracts to verify voter identities, record votes, and determine outcomes.

A savvy developer could build a smart contract to split dining costs with friends or the monthly rent with roommates. You could run an investment club that uses smart contracts to collect and distribute funding.
Smart contracts can be used to establish and complete almost any agreement.

Why Use Smart Contracts?

There are several reasons for using smart contracts:

  • Autonomy: Under a smart contract, parties to the contract do not require go-betweens or facilitators to enable a transaction, reducing opportunities for external interference.

  • Safety: Smart contracts are safer than traditional contracts, thanks to cryptography. They also duplicate documents regularly, which protects transacting parties in the event of data loss.

  • Cost savings: Smart contracts eliminate the need for third parties and the payment of their fees.

  • Efficiency: Smart contracts save time that would otherwise be spent signing paper documents, dispatching those documents, dealing with third parties, and carrying out other administrative tasks.

How Is Risk Managed in Smart Contracts?

It is important to follow the best practices for writing smart contracts on whichever blockchain is chosen to lodge them. Each blockchain has a preferred programming language; EOS favors C++, Ethereum uses Solidity, and NEO uses JavaScript. Following their respective best practices can prevent the inclusion of errors in the code that governs the operation of a smart contract.
Because smart contracts are self-enforcing and immutable, once they are deployed on a blockchain, any bugs present in their code are also unalterable.
Potential coding vulnerabilities make security audits of smart contracts critically important. Most blockchain developers put their code through extensive reviews that can last for weeks after development. These reviews improve the chances of discovering bugs or flaws in the code and fixing them before it is activated.

Criticisms on Smart Contracts

There are also several criticisms and challenges associated with the use of smart contracts. Some of the main criticisms include:

  • Complexity: Smart contracts can be complex and difficult to understand, which can make them difficult for non-technical users to use. This can limit the adoption and usage of smart contracts.

  • Lack of legal recognition: Smart contracts are not always legally binding in all jurisdictions, which can create confusion and make it difficult to enforce the terms of a contract.

  • Security Risks: Smart Contracts by itself is secure, but the code on which they are built on might have bugs and vulnerabilities, also the oracles (systems that provide external data to the contract) can be compromised and can tamper with the data being fed to the contract, making it act in an unintended way.

Overall, even though smart contracts have a lot of potential advantages, it is crucial to be mindful of the technology’s drawbacks as well. It is important to ensure that smart contracts are developed and deployed in a secure, reliable, and consistent manner to reap the benefits it offers.

What Does the Future of Smart Contracts Look Like?

Smart contracts introduce a new, transparent way of doing business, where peer-to-peer transactions can happen in a trustless environment. Moreover, advanced smart contract infrastructure has the potential to revolutionize shipping, logistics and trade on a global scale. Smart contracts can make transactions faster, cheaper, and more efficient from real estate to construction as well as supply chain management.
Currently, smart contracts are mainly used in the fintech space, where transaction efficiency and transparency are critical. Yet, as more blockchain networks launch their smart contract functionalities, other industries may also find more uses for the technology.
Fintech giant PayPal has already recognized the benefits of cryptocurrency, launching “Checkout with Crypto,” an upgrade that enables customers in the U.S. to use cryptocurrencies in their PayPal wallet — making crypto payments possible for millions of businesses, while also increasing the utility of digital assets. The platform is also rumoured to be developing a crypto “Super App,” with other fintech platforms likely to follow suit.
The utility industry is also adopting smart contracts, leveraging them to boost the efficiency of energy distribution in microgrids. Smart contract algorithms monitor the real-time usage of each user, as they are linked to smart sensors enabled by IoT (internet of things). Smart contracts make sure that no surplus of energy is distributed in the network, while they can enable users to pay for their energy consumption in real-time, using cryptocurrencies.


A blockchain is nearly impossible to hack or shut down. That makes it safe and easy to do business with anyone, whether you know that person or not. There is no way for the other party to back out of a deal after you’ve honored your obligations, and there is no point in the process when loss or fraud can occur. Once a smart contract’s conditions are met, its terms are enforced automatically using a blockchain, a digital, pseudonymous, public ledger that authenticates and permanently records every transaction.

Author: Abdul
Translator: Binyu
Reviewer(s): Matheus, Hugo, Joyce, Ashley
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