Smart contract
A program that moves money and can no longer be changed
What is it?
The name misleads. It is not a contract in the legal sense, and there is nothing smart about it either.
The closest thing is a vending machine. You put something in, the machine checks against fixed rules and hands something out. It does not negotiate, makes no exceptions and asks nobody. The difference from the machine on the corner: this one stands on thousands of computers at once, anyone can read its blueprint, and nobody can open it up - not even the person who built it.
That is precisely the point that explains everything else. Immutability is the whole idea, because only that lets you trust the machine without trusting its operator. And for the same reason a flaw in it cannot be corrected.
An example
A lending contract works like this: whoever puts money in receives interest. Whoever borrows must deposit more than they receive - say 150 euros in one token to borrow 100 euros in another.
If the value of the deposit falls below a set limit, the contract sells it automatically and settles the debt with it. Nobody calls, nobody sends a reminder, nobody decides. The contract calculates, and when the number is below the threshold it happens.
Where does a risk come from?
From three properties that are harmless on their own and together make the difference.
| It holds money | Whoever deposits hands the funds to the contract. They are then no longer in your own wallet. |
|---|---|
| It is public | The code is readable by anyone. That is intended - but it also means anyone can look for flaws, at any time, unnoticed. |
| It is immutable | A flaw once found stays. There is no update that closes it overnight. |
A flaw in a smart contract is therefore not a nuisance but a standing invitation with a price tag - and the price is whatever sits in the contract.
Why this matters for cover
Because it produces a loss that can be described - and only describable losses can be transferred.
A contract has an address. Every movement on it is in the blockchain and verifiable by anyone. That allows a condition two sides need not argue about: this contract, in this period, lost funds.
That is why smart contract risk is the one with the longest history of cover products. What follows from it, and which questions a wording has to answer, is set out under smart contract risk.
Where this leads
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What happens when the flaw is exploited, and which seven questions a wording has to answer.
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Several smart contracts that together make an application - and why “the protocol is covered” is an imprecise statement.