Smart Contracts and Decentralized Finance

Abstract

We explain the mechanics of smart contracts. We then highlight the benefits of smart contracts, such as overcoming commitment problems. We also discuss limitations, such as the difficulty for smart contracts to access information external to the blockchain and the difficulty of integrating smart contract code with traditional legal enforcement. We further highlight how the absence of a trusted intermediary inflates implementation costs for blockchain applications. We conclude with a discussion of the most prominent smart contract applications in decentralized finance: token issuance (e.g., initial coin offerings, nonfungible tokens), decentralized exchanges, and protocols for loanable funds. Our survey covers both institutional details and relevant literature. Expected final online publication date for the Annual Review of Financial Economics, Volume 15 is November 2023. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.