Blockchain Smart Contracts And How They Are Used, Explained

Smart contracts are blockchain programs that are different from computer programs. Here’s how they work, and why they are important for Web3 apps.

Anyone who has spent time in cryptocurrency, blockchain, and Web3eventually seesthe term “smart contract“, but many people don’t know what it means. Confusingly, smart contracts have nothing to do with legal contracts, despite being inspired by them, and are fundamentally different from web apps and computer programs.Despite being the most powerful technology to emerge from blockchain, most people have never heard of them.

Smart contracts were first conceptualized by Nick Szabo in 1995 (who may or may not beSatoshi Nakamoto, the anonymous creator of Bitcoin), who had the idea of “transactionprotocols“that automatically execute the terms of a contract between two parties over the internet. This would have been very useful, assmart contracts could reduce or eliminate the risk ofcounterparties refusing to uphold theirendof acontract, avoiding costly court battles. Unfortunately, there exists no way todo this without relying on a third party tohost the contract, who could potentially alter or halt the code, thus rendering the idea pointless. Also, unlike cryptocurrency, digitalcurrencyis not programmable,and bank-to-bank money transfers are inefficient and reversible. These limitations are whysmart contracts didn’t exist before the Ethereum blockchain went live 20 years later in 2015.

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Smart contractsare often describedlike regular contracts, butthis is misleading and limiting.They are actually tiny programs running on a second-generation blockchain (i.e. Ethereum),where crypto wallets and other smart contracts can interact with them.Almost allcryptocurrency and NFTsarestandardized smart contracts that track token balances,allowingother smart contracts to act like middlemenor vending machines, eliminating counterparty risk during trades, transactions, anddistributions. Tokencontracts are essential toWeb3, cryptocurrency, andblockchain-basedmetaverses,as they create transferrable digital property.Smart contracts can create utilities,like “airdrop“contracts that transfer tokens to many accounts simultaneously, or “multi-sig” contracts that require multiple signatures to confirm an action. Smart contracts are used extensively in Decentralized Finance (“DeFi“), a blockchain sector that replaces common financial applications with smart contracts, and in November 2021, DeFi contracts held nearly $100B of value (according to DeFi Pulse). Smart contract capabilities are extensive, with many more in development.


Smart Contracts Are Very Powerful,For Better OrFor Worse


Smart Contracts Handle Money, NFTs, and Data

Smart contracts have many features. Websites and web apps can call smart contract functions, providing an easy interface for them. “Public” functions are open for anyone to use,while sensitive functionscan be restrictedto authorized users/contracts.Nobody can alter or halta smart contract’s functions, and crypto/NFT transfers are irreversible and take only a few seconds.They are also reliable, and will continue running during high-volume bottlenecksthat otherwise crash cryptocurrency exchanges.Smart contracts are autonomous “residents” of their blockchain’s ecosystem, requiring no maintenance or expense once they are deployed, and they cannot be destroyed or modified (with some exceptions).


Smart contracts do have problems, as smart contract “bugs” account forbillions inlost/stolen crypto over the past sevenyears. Because they can’t be modified, fixing asmart contract works likeamanufacturer’srecall, where a new/upgraded contract is deployed and users must manually move their tokens over. Consequently, smart contracts aredeveloped like hardwareinstead of software,andprofessional security audit and inspection servicesareoften hired to findvulnerabilities before launch. Smart contracts are limited to their native blockchain’s ecosystem, and require the use of “bridges“tomove assetsto other blockchains,makingblockchain bridges big targets for hackers. Finally, smart contracts are “blind” to thereal world, and must be fed data through special services, which can cause serious problems if the data is wrong (even momentarily).


Smart contracts are the most powerful technology within blockchain, giving rise tocryptocurrencies, NFTs, DeFi, Web3 apps, blockchaingames, decentralized metaverses, and far more. Theyare theengines that drive blockchain’s adoption forward,being given littlecredit until things go wrong. While their potential is massive, developers are not yet familiar with their quirks, as complex designs introducemore (expensive) problems, and years oftrial and error areneeded before blockchain smart contracts will beready for mass-adoption.

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Source: DeFi Pulse

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