02/19/2026

7 min read

What are Smart Contracts and how do they work?

Smart contracts are changing how agreements are made and executed. These digital contracts are based on blockchain technology and enable automated execution. To achieve that, conditions are embedded directly in the code, verified and carried out without any intermediaries.

Smart contracts have taken on a key role within the Ethereum network, demonstrating how versatile blockchain applications can be. In this article, we explain what smart contracts are, how they work and where they are used. We also show you the advantages and risks of the technology.

Definition: Smart contracts are digital contracts that are automatically executed once predefined conditions on the blockchain are met.
Significance: Smart contracts are seen as the technical foundation for many applications in cryptocurrencies and decentralised platforms.
Examples: Use cases for smart contracts range from automated insurance payouts and property transactions to digital identities.
Advantages and disadvantages: Advantages include automation and transparency, while risks arise mainly from faulty code and unclear legal classification.

Definition: smart contracts explained simply

A smart contract is a digital agreement in which all contract terms are directly embedded in the code. It runs on a blockchain, meaning a decentralised network that documents transactions transparently and makes them tamper-proof. Smart contracts automatically execute specific actions once predefined conditions are met, without a central intermediary. They are considered decentralised software solutions that can process workflows securely and without manual intervention.

How do smart contracts work?

Smart contracts automatically implement digital contract terms as soon as certain triggers occur. The contract is written in code and stored on a blockchain such as Ethereum. The blockchain ensures the process is secure, traceable and free from manual intervention.

Creation and deployment

A smart contract is developed in a specialised programming language, e.g. Solidity.
The code contains all conditions and corresponding actions.
Once created, the smart contract is stored on the blockchain and made publicly viewable.

Activation by conditions

The blockchain monitors whether the conditions embedded in the code are met.
Possible triggers include for example a specific date, receipt of payment or a confirmation.
When a condition is met, the action defined in the code is automatically executed.

Execution without intermediaries

Typical actions include token transfers, digital access rights or automated processes.
The execution is decentralised, with no involvement from a central authority.
All transactions are transparently recorded on the blockchain.

Why are smart contracts important?

Smart contracts enable processes between parties who do not know or trust each other to be carried out digitally. They serve as a technical foundation for many applications in the field of cryptocurrencies and beyond. Especially in decentralised projects, they ensure that transactions and actions run automatically and transparently.

By integrating into blockchains such as Ethereum, smart contracts can map entire business logic, for example in decentralised finance (DeFi), digital identities or non-fungible tokens (NFTs), which are digital proofs of ownership for unique assets like art or collectibles.

This opens up new possibilities for businesses, software projects and platforms to translate complex conditions into code and execute them reliably.

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Historical development of smart contracts

The idea behind smart contracts is older than many assume. As early as the 1990s, there were discussions about how contract terms could be represented digitally. This was long before blockchains or cryptocurrencies like Bitcoin emerged. The key stages of this development show how a theoretical idea became a key technology within modern blockchain platforms.

Milestones in development at a glance:

Term coined (1994): Cryptographer Nick Szabo coined the term "smart contract" and proposed representing contract terms in digital protocols.
Bitcoin and early scripts (2009): With the launch of the Bitcoin network, a simple but limited scripting system was introduced, enabling automated transactions.
Ethereum and programmable contracts (2015): Ethereum was developed with the aim of making smart contracts a core function, allowing complex contract logic to be executed on a blockchain for the first time.
Wider adoption (from 2017): The rise of ICOs and DApps significantly increased interest in smart contracts.
Part of many blockchain platforms (today): In addition to Ethereum, networks like Solana or Avalanche also support their own smart contracts with varying technical approaches.

Did you know

ICOs were among the first ways to finance new blockchain projects. Tokens were sold, often in exchange for cryptocurrencies like Ether. They are now used less frequently, as new models such as IEOs or IDOs have emerged.

What are some examples of smart contracts?

Smart contracts are used where processes need to be automated, secure and function without intermediaries. They are particularly helpful when several parties, e.g. companies, are involved and trust can be replaced by technology. And it's not just about cryptocurrencies, as smart contracts have already expanded into other areas of life and business.

Typical use cases for smart contracts:

Insurance: In certain claim cases, smart contracts can trigger payments automatically once all proofs are digitally provided.
Property: Ownership transfers can be processed without a solicitor or estate agent once all contract terms are met.
Logistics: Deliveries are automatically documented and confirmed once shipments reach certain locations or meet specific conditions.
Digital identities: Smart contracts can verify and release individual identity traits without disclosing personal data.
Decentralised finance (DeFi): Loans, interest payments or token swaps are processed automatically without banks or central entities.
Non-fungible tokens (NFTs): When buying or reselling an NFT, a smart contract ensures that the ownership change is automatically recorded on the blockchain.

Advantages and disadvantages of smart contracts

Smart contracts are considered an essential component of many blockchain applications. But like any technology, they come with strengths and risks that should be considered.

Advantages

Automation: Processes are executed without manual intervention once conditions are met.
Security: Cryptographic methods make data and processes difficult to manipulate.
Transparency: Code is publicly visible and execution can be tracked.
Cost savings: Intermediaries like notaries or banks can be removed in certain processes.
Efficiency: Transactions are processed quickly and without detours.
Reliability: Once deployed, smart contracts execute their functions exactly as programmed.

Disadvantages

No retroactive changes: Code errors often cannot be corrected afterwards.
Dependence on developer code: What is coded will be executed, even if logic errors exist.
Limited legal clarity: Clear legal definitions are still lacking in many countries.
Technical entry barrier: Creating and auditing contracts requires programming knowledge.
Risk in complex processes: The more conditions are coded, the more error-prone the smart contract may become.

Platforms for smart contracts

Smart contracts require a suitable technical environment to run reliably. Various blockchain platforms offer their own systems with different strengths and use cases. These include:

Ethereum: the first blockchain to comprehensively support smart contracts and the foundation for many decentralised applications
Solana: offers very fast transactions with low fees, suitable for applications requiring high performance
Cardano: takes a scientific approach to development and allows the execution of smart contracts with a focus on security and scalability
Binance Smart Chain: an inexpensive and fast alternative where many smart contracts and DeFi projects operate
Polkadot: enables the execution of smart contracts across multiple interconnected blockchains via so-called parachains

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Conclusion: Are smart contracts still a key part of the crypto world in the future?

Smart contracts have become an integral part of modern blockchain technologies. They enable digital agreements to be executed automatically, securely and transparently without central authorities. With their broad use in areas such as financial services, digital identity and decentralised applications, they are an essential tool in the world of cryptocurrencies.

Market analysis shows that the smart contracts market reached a value of around $2.14 billion in 2024 and could grow to approximately $12.07 billion by 2032. This makes it clear that smart contracts could evolve beyond the crypto world into a key infrastructure technology for automated transactions and digital agreements.

Frequently asked questions about smart contracts

We answer the most common questions about smart contracts to give you a comprehensive overview.

A traditional contract is a legally binding agreement between parties, usually recorded in writing and enforced in court in case of disputes. A smart contract, on the other hand, is a piece of code on a blockchain that automatically executes predefined conditions once they are met. Whether a smart contract is legally enforceable depends on the legal framework in place and is not yet clearly defined in all countries.
Whether a smart contract is considered a legally binding agreement depends on the individual case in Germany. Under current German law, a smart contract can meet the requirements of a contract – such as offer and acceptance – if both parties agree and the terms are clear. However, there is no specific law governing smart contracts. Instead, general contract law applies, such as provisions from the German Civil Code (BGB). It's also important to note that formal requirements, such as written form, may still apply to certain contract types. Whether and how a smart contract meets these requirements must be assessed individually.
Smart contracts are considered tamper-proof, as they are stored on the blockchain and executed automatically. However, their actual security depends heavily on the quality of the code. Poorly written or insufficiently tested smart contracts can contain vulnerabilities – as seen in the DAO hack, where Ether worth millions was stolen. To minimise risks, smart contracts should undergo independent security audits and be thoroughly tested before deployment.