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What are Smart Contracts?

Smart contracts are simply programs stored on a blockchain that run when predetermined conditions are met. They typically are used to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without any intermediary’s involvement or time loss. They can also automate a workflow, triggering the next action when conditions are met. What makes smart contracts “smart,” however, is that the terms are established and executed as code running on a blockchain, rather than on paper sitting on a lawyer’s desk.

Supposedly, the idea was proposed in the 1990s by Nick Szabo, a pioneer of modern computer science, who defined them as a set of virtual promises with associated protocols to enforce them. Despite the name, smart contracts are not legally binding contracts. Their main function is to programmatically execute business logic that performs various tasks, processes or transactions that have been programmed into them to respond to a given set of conditions. Legal steps must be undertaken to link this execution to legally binding agreements between parties.

To illustrate the function and role of a smart contract, the analogy of a vending machine is most relevant. When buying a product on a vending machine, the underlying sale agreement is between the buyer and the owner of the vending machine, and the machine acts based on the actions of the buyer and instructions pre-set by the owner to perform the agreement between the parties.

Arguably, a smart contract is a tool to implement a sale agreement between the NFT owner and the buyer, like a vending machine. Smart contracts, being self-executing, are able to verify that the terms of the contract have been met and execute the terms without the need of an intermediary or central authority. Once implemented, the smart contract is updated and the code will become immutable as soon as it is logged on the blockchain. Since a smart contract’s code on a blockchain is public, any person who uses smart contracts and has the requisite coding skills can inspect the code and verify the authenticity of the smart contract.

Operations of a Smart Contract

The operation of a smart contract is similar to other blockchain transfers. These are the necessary steps:

  1. A user initiates a transaction from their blockchain wallet.
  2. The transaction arrives at the distributed database, where the identity is confirmed.
  3. The transaction, which may be a transfer of funds, is approved.
  4. The transaction includes the code that defines what type of transaction is to be executed.
  5. The transactions are added as a block within the blockchain.
  6. Any change in contract status follows the same process to be updated. 

NFTs and Smart Contracts

NFTs are minted through smart contracts that assign ownership and manage the transferability of the NFT’s. When someone creates or mints an NFT, they execute code stored in smart contracts that conform to different standards, such as ERC-721. This information is added to the blockchain where the NFT is being managed

NFTs use identification codes and metadata that is logged and authenticated on cryptocurrency blockchains, which renders each NFT represented on the blockchain a unique asset. The smart contract contains information regarding the NFT including the creator of the work, other parties’ entitled to royalties each time the NFT is sold, and the ownership history of the work. Most NFTs are not stored on the blockchain as storing that much data on the blockchain is expensive and consumes a lot of electricity. Therefore, smart contracts usually contain a link to the work they represent which can be accessed by the owner only.

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