The way agreements are both created and enforced in an increasingly digital world is being revolutionised by smart contracts. But exactly what are smart contracts? And how do smart contracts work within blockchain networks?
In this guide, we’ve rounded up everything you need to know – from a basic explanation to the different types of smart contracts in blockchain and how industries globally are adopting them.
What Are Smart Contracts?
Smart contracts are digital agreements which have their specific terms and conditions written directly into their lines of code. They’re also self-executing – meaning, once deployed using blockchain, a smart contract will automatically come into force once the conditions are met, carrying out its instructions.
This removes the need for a middleman, reducing human error, while also cutting costs and minimising delays.
Smart contracts in blockchain operate on decentralised platforms, providing airtight security that each one will exactly follow its programming.
Thanks to core features associated with blockchain, such as distributed consensus, transparency, and immutability, smart contracts are also highly secure and resistant to tampering.
How Do Smart Contracts Work?
Defining the agreement: The first step of a smart contract is for all the parties involved to agree on set outcomes or rules.
Writing the code: These conditions and outcomes are then translated into code using a specific smart contract language for blockchain.
Blockchain deployment: Once the smart contract is uploaded to a blockchain system, it’s visible across the digital space and becomes immutable.
Automatic trigger: As soon as the pre-set conditions are met – whether that’s a deadline, or the receipt of payment – the contract executes its instructions without the need for further human input.
Key Features of Smart Contracts
Trustlessness: Since it’s the blockchain code enforcing the rules written in the contract, the parties involved don’t need to rely on trust for the outcomes.
Accuracy: In a similar vein, automating the execution of an agreement means there’ll be significantly fewer errors when processing contracts.
Autonomy: Thanks to the way smart contract code works, once an agreement is deployed, it runs fully independently.
Efficiency: The outcomes of a contract kick in as soon as the conditions are met, greatly improving speed for all parties.
Security: Blockchain features such as encryption and decentralised verification make smart contracts tamper-proof.
Types of Smart Contracts in Blockchain
Even within the advanced world of blockchain ecosystems, it’s impossible to create an all-purpose smart contract. Instead, the main types of smart contracts in blockchain are broken down by purpose:
Smart Legal Contracts: Designed as a blockchain alternative to traditional legal agreements, these smart contracts simply use code instead of paperwork to enforce their terms. When they’re tied to the real-world identities of the parties involved, these can also be recognised in legal jurisdictions.
Decentralised Autonomous Organisations (DAOs): These are blockchain-native organisations where central leadership has been replaced by community voting. The entire operation is run by smart contracts, with rules and finances both managed within the blockchain framework.
Application Logic Contracts (ALCs): Key for the creation of more complex digital systems, ALCs help manage decentralised applications (dApps) by enforcing business logic and integrating with other smart contracts.
What Are Smart Contracts’ Challenges and Limitations?
Despite the vast potential of smart contracts, they’re still facing a series of challenges, such as:
Legal recognition: While smart contracts are gradually becoming more widespread, many jurisdictions still don’t acknowledge these as legally binding.
Coding errors: Even though smart contracts go a long way to reducing human error, they’re not immune to bugs or other vulnerabilities within their code, which leave them open to exploitation.
Data dependency: Often, smart contracts gain information about whether conditions are met from third-party services operating off-chain, which can be a possible weak point.
Scalability: Increasing demand for running smart contracts on popular blockchains can clog up the network and make transaction fees skyrocket.
What Are Smart Contracts’ Real-World Use Cases?
Real estate firms can use smart contracts to automate anything from rent payments to property transfers.
Supply chain can be streamlined with smart contracts that track goods in real time and release payments upon delivery confirmation.
Insurance claims can be automatically triggered by third-party reports on events such as flight delays/cancellations.
Decentralised finance institutions can bypass traditional banks and conduct operations such as lending or staking through smart contracts instead.
Healthcare organisations might be able to make accessing medical records securely more efficient, and automate the management of consent.
Read more about smart contracts in action.
The Future of Smart Contracts
So, what are smart contracts in blockchain going to look like in a few years? As blockchain technology matures, they’re only expected to grow in popularity, bringing improved security and user experience which entice more industries to adopt them.
Experts are forecasting increased legal integration with enforceable legislation, standardisation designed to improve reliability and compatibility, and interoperability that enables them to function across blockchain platforms.
Smart contracts are helping shape the decentralised future through streamlined operations and enhanced trust, empowering businesses to maximise their potential.
Find out more about the next cutting-edge blockchain technologies, including smart contracts – register for the London Blockchain Conference 2025.
