Smart Contracts 101

Smart contracts are an essential part of crypto but do they exist on the Bitcoin blockchain?

As part of our "Prosper 101" educational series, we explore what are smart contracts and whether similar self-executing contracts work on the Bitcoin network.

What Are Smart Contracts?

Smart contracts are self-executing digital agreements between two parties, stored on blockchain networks. They are designed to be automatically executed when the conditions of the contract are met, sometimes triggering an onward reaction.

The decentralized and transparent nature of blockchains makes smart contracts secure and tamper-resistant. Once deployed, the contracts cannot be altered and all parties are instantly aware of the outcome of the agreement. Additionally, because the contracts are automated, there's no need for third-party involvement.

Does Bitcoin Have Smart Contracts?

Certain rudimentary smart contract-like functionalities are built into Bitcoin's core. In a way, every Bitcoin transaction uses basic smart contract functionality—it's one of the key features that helps Bitcoin to remain trustless and decentralized.

The original Bitcoin protocol established a set of conditions that had to be satisfied in order to transfer Bitcoins between users, such as the user signing the transaction with the correct private key. This can be considered as a type of basic smart contract. Bitcoin later evolved to support multi-signature (multisig) transactions, which require a defined number of private keys to sign off on a transaction before it is considered valid. This increases security by mitigating single points of failure.

However, Bitcoin's scripting language and script-based contracts are more limited than, for example, Ethereum's, and it does not have the same level of programmability and ability to run complex, independent smart contract applications. Ethereum was designed from the ground up as a "world computer", enabling sophisticated programmable smart contracts, while Bitcoin's smart contract-like capabilities are more foundational, basic, and constrained in nature. Despite Bitcoin’s simplicity, it prioritizes security and decentralization over advanced programmability.

Bitcoin's Transaction Types with Smart Contract-like Functionalities

1. Pay-to-Public-Key-Hash (P2PKH)

This is the basic form of making a transaction on the Bitcoin network. P2PKH scripts lock Bitcoins to a specific Bitcoin address and can only be unlocked by providing a valid digital signature that corresponds to the private key associated with that address. This ensures that only the owner of the private key can spend the Bitcoins sent to that address.

2. Multi-Signature (Multisig)

This is a type of Bitcoin transaction that requires more than one party to approve a transaction before completion. Bitcoin multisig transactions are normally used to release funds or perform actions that require a predefined number of signatures to be acquired in order for the agreement to be executed.

3. Time-locked Transactions

Known as Time-locked Transactions, these are Bitcoin transactions that are only valid after a certain time, date or block, assuming all of the requirements of an agreement are met. If these requirements are not met, the transaction is cancelled.

4. Pay-to-Taproot (P2TR)

Bitcoin's Taproot upgrade, released in 2021, introduced a new script type known as Pay-to-Taproot (P2TR). P2TR is a script that introduced new signature types offering better security and flexibility.

Smart Contracts on Bitcoin Layer 2s

Bitcoin Layer 2s have also introduced new features to the Bitcoin network, while still taking advantage of the security and immutability of the Bitcoin mainnet. The execution of smart contracts on L2s allows for greater programmability, higher scalability, and improved efficiency.

Here are some examples of smart contract-compatible Bitcoin L2s:

1. Rootstock (RSK)

Rootstock is an EVM-compatible Bitcoin sidechain that enables smart contract functionality by allowing developers to easily port smart contracts and decentralized applications (dApps) over from Ethereum. RSK therefore supports the same smart contract programming language as Ethereum (i.e., Solidity).

2. Stacks

Stacks is a blockchain that aims to bring greater smart contract functionality (and dApps) to Bitcoin. Developers use an easily-understood programming language called Clarity, which is optimized for security and predictability.

3. Lightning Network

The Lightning Network is a decentralized network using smart contract functionality to establish off-blockchain payment channels enabling fast and affordable peer-to-peer transactions.