Crypto FAQ: What is a smart contract and how does it work?

• Alt. Phrasing: What is a blockchain smart contract?; What is a digital contract?

---

• Defn: smart contract
  [compound noun: adjective "smart" (automatic execution of) + noun (financial) "contract"]
  

  A smart contract refers to a computer algorithm program (software code) hosted on a cryptocurrency blockchain (Digital Ledger Technology [DLT]) that executes (enforces) the legal terms of a financial agreement between two or more parties. A smart contract typically uses the cryptocurrency associated with its host blockchain to legally bind and enforce the subject financial agreement. Smart contracts allow cryptocurrency software developers to build applications that take advantage of blockchain accessibility, reliability, and security to automatically execute a wide range of financial applications, ranging from currency trading and loans, to insurance and gaming.

Smart contracts may be considered a type of financial account on a blockchain, which typically means that they have an account balance in the blockchain's native cryptocurrency, and they initiate cryptocurrency credit/debit transactions across the blockchain network. Smart contracts typically define rules, like a regular financial contract, and automatically enforce them via the smart contract computer program code. Smart contracts cannot be deleted by default, and their financial transactions (e.g., credits/debits) are generally irreversible.

The introduction of smart contracts differentiates first generation blockchains and cryptocurrencies blockchains (e.g. Bitcoin/BTC) from second generation cryptocurrency blockchains (Ethereum/ETC). Indeed, in 2015 the Ethereum/ETH project, led by Vitalik Buterin, pioneered the innovative integration of smart contracts into blockchains, which serves as the foundation for a wide range of Decentralized Finance (DeFi) applications.

Computer Science Perspective

From a computer science perspective, the inclusion of smart contracts into blockchains makes them Turing complete and consequently capable of executing any financial algoirthm relevant to a financial contract application. For example, an Ethereum smart contract is simply a computer program (software code) that runs on the Ethereum blockchain. More specifically, its a collection of software code (its "functions") and data (its "state") that resides at a specific IP (Internet Protocol) address on the Ethereum blockchain that conditionally executes when relevant events occur (receipt of payment, escrow terms are satisfied for both parties, etc.).

Digital Economic (Cryptoeconomic) Perspective

From a digital economic perspective, the inclusion of smart contracts into blockchains enables them to support a wide range of Decentralized Finance (DeFi) applications that include, but are not limited to, currency exchange, saving with interest, lending, trading, escrow, insurance, gambling, gaming, etc.

---

Compare: Distributed Ledger Technology (DLT) law
Contrast: (traditional legal/financial) contract
Reference(s):
* smart contract [Wikipedia]
* An Introduction to Smart Contracts and Their Potential and Inherent Limitations, Harvard Law [Stuart 2018]