Smart contracts were first coined by American computer scientist Nick Szabo in 1994. In his seminal writing, he gave a broad smart contract definition as follows: “a computerized transaction protocol that executes the terms of a contract,” with general objectives to “satisfy common contractual conditions, minimize exceptions both malicious and accidental, and minimize the need for trusted intermediaries.”

While a general notion of smart contracts could be seen in systems like vending machines (e.g., a specific code leads to an expected snack), blockchains formed the foundation of smart contracts that were digital, tamper-proof, and permissionless. The introduction of the Bitcoin blockchain in 2009 supported arguably the first protocol smart contract—establishing a set of conditions that had to be satisfied to transfer Bitcoins between users on the network. These conditions include the user signing the transaction with the correct private key that matches their public address (akin to a password linked to a specific account) and the user owning enough funds to cover the transaction.

The Bitcoin blockchain then evolved to offer another major type of smart contract in 2012 called a multi-signature transaction. A multisig transaction requires a defined number of people (public keys) to sign a transaction with their private keys before it’s considered valid. This increases the security of user funds by mitigating single point of failures like a stolen or lost private key. 

Most traditional digital agreements involve two parties that don’t know each other, introducing risk that either participant won’t uphold their commitments. To resolve counterparty risk, digital agreements are often hosted and executed by larger, centralized institutions like a bank that can enforce the contract’s terms. These digital contracts can be directly between a user and a large company or involve a large company acting as a trusted intermediary between two users. While this dynamic allows many contracts to exist that otherwise wouldn’t take on such risk, it also creates a situation where the larger, centralized institutions exert asymmetrical influence over the contracts.

Token smart contracts are used to create, track, and assign ownership rights to specific digital tokens existing on blockchain networks. The token contract programs functionalities into the tokens it issues, providing holders features like utility/insurance in a dApp (utility token), voting weight in a protocol (governance token), equity in a company (security token), ownership claim to a unique real-world or digital asset (non-fungible token), and more. For example, the FIL token is used to pay for Filecoin’s decentralized storage services and the COMP token allows users to participate in the governance of Compound protocol.

Decentralized finance (DeFi) consists of applications that use smart contracts to recreate traditional financial products and services such as money markets, options, stablecoins, exchanges, and asset management, as well as combine multiple services to create new financial primitives via permissionless composability. The smart contract can hold user’s funds in escrow and distribute them between users based on predefined conditions. For example, BarnBridge uses smart contracts to automate trades for users wanting fixed asset exposure to a price pair (e.g., 45% token A, 55% token B), and Aave uses smart contracts to facilitate lending and borrowing in a permissionless and decentralized manner.

Blockchain-based games use smart contracts for tamper-proof execution of in-game actions. One example is PoolTogether, a no-loss savings game where users stake their funds in a shared pool that is then routed into a money market where it earns interest. After a predefined time period, the game ends and a winner is randomly awarded all the accrued interest while everyone else can withdraw their original deposit. Similarly, limited-edition NFTs can have fair distribution models and RPGs can support unpredictable loot drops using randomness, helping to ensure all users have a fair shot at getting rare digital assets. Many projects access randomness using Chainlink Verifiable Random Function (VRF)—a random number generator (RNG) that uses cryptography to prove it's tamper-proof, meaning the RNG process is publicly auditable.

Parametric insurance is a type of insurance where a payout is tied directly to a specific predefined event. Smart contracts provide tamper-proof infrastructure for creating parametric insurance contracts that trigger based on data inputs. For example, crop insurance can be created using smart contracts, where a user purchases a policy based on specific weather information like seasonal rainfall in a geographic location. At the end of the policy, the smart contract will automatically issue a payout if the amount of rainfall in the specific location exceeds the original stated amount. Not only do end-users receive timely payouts with less overhead, but the supply side of insurance can become open to the public via smart contracts. The smart contract allows users to deposit funds into a pool and then distributes collected premiums to pool participants based on the percentage of their contribution to the pool.