What are Smart Contracts on Bitcoin?

In theory Smart contracts are self-executing agreements with rules written in code, eliminating the need for intermediaries. When predefined conditions are met, these contracts automatically execute transactions.

Smart Contracts became a buzzword for many altcoin projects that push complex, bloated smart contract platforms.

Bitcoin is different. It is decentralized and censorship resistant.

How Smart Contracts work on Bitcoin

Bitcoin uses a scripting language called Script, which allows users to set conditions for spending bitcoin. Every Bitcoin transaction is technically a smart contract, as it follows specific rules to determine who can unlock and transfer the funds.

Key Features of Bitcoin’s Smart Contract Model:

• Security-First Approach – Bitcoin’s Script is not Turing complete, meaning it does not allow infinite loops or arbitrary logic. This prevents denial-of-service (DoS) attacks, which plague other blockchains.
• Efficiency – Unlike Ethereum-style contracts, which run complex computations on-chain, Bitcoin smart contracts are simple and lightweight.
• Censorship Resistance – Because Bitcoin smart contracts operate within the UTXO model, they are much harder to censor. Bitcoin’s scripting capabilities may not be as flashy as those on other platforms, but they are far more robust and battle-tested.

A Brief History of Bitcoin Smart Contracts

Bitcoin was designed with smart contracting abilities from the start. However, its capabilities have evolved over time:

• 2012: Pay-to-Script-Hash (P2SH) – Allowed users to lock bitcoin in more complex spending conditions without revealing the script upfront.
• 2017: Segregated Witness (SegWit) – Introduced efficiency improvements that benefited smart contracts, particularly the Lightning Network.
• 2021: Taproot Upgrade – Introduced MAST (Merkelized Alternative Script Trees) and Schnorr Signatures, significantly enhancing smart contract privacy and flexibility. These upgrades demonstrate Bitcoin’s slow but steady approach to innovation, ensuring that changes strengthen the network rather than introduce unnecessary risks.

Types of Smart Contracts on Bitcoin

Bitcoin’s scripting language supports a variety of smart contracts, ranging from simple to advanced.

Basic Smart Contracts

1. Pay-to-Public-Key-Hash (P2PKH) – The standard transaction type, requiring a valid digital signature to spend funds.
2. Multi-Signature (Multisig) – Requires multiple private key signatures to authorize a transaction, often used for escrow or secure storage.
3. Time-Locked Transactions – Funds can only be spent after a certain time period, useful for security and inheritance planning.

Advanced Smart Contracts

1. Pay-to-Script-Hash (P2SH) – Enables users to send bitcoin to a script hash rather than a standard address, keeping contract details private until spending occurs.
2. Taproot Contracts (P2TR) – Allows for complex smart contracts without sacrificing privacy, making all transactions look the same on-chain.
3. The Lightning Network - Hashed Time-Locked Contracts (HTLCs) – The foundation of the Lightning Network, enabling instant and low-cost transactions without trust. Unlike Ethereum, which forces all smart contracts to run on the base layer, Bitcoin encourages off-chain execution whenever possible, reducing congestion and fees.

Taproot’s Impact

Taproot, activated in November 2021, was a game-changer for Bitcoin smart contracts.

Key Benefits:

• Privacy Improvements – Multisig and complex contracts are now indistinguishable from simple transactions and they increase privacy in making chain analysis much harder.
• Lower Fees – Taproot transactions require less data which results in lower transaction fees.
• By using Merkelized Alternative Script Tree (MAST), Bitcoin contracts now reveal only the necessary conditions, keeping the blockchain clean. With Taproot, Bitcoin’s smart contract capabilities expanded without compromising security, unlike the reckless upgrades seen in other chains.

Smart Contract Layers on Bitcoin

Bitcoin’s base layer remains intentionally simple, but additional layers extend functionality.

The Lightning Network

• Uses HTLCs to enable instant, low fee payments.
• Smart contracts ensure that payments are trustless and cannot be stolen.
• Improves Bitcoin’s scalability by moving small transactions off-chain: Even while fees are low, it can become costly or even result in a loss of money if small UTXO’s are used, because in a high fee environment spending this coins uses a lot of storage on the blockchain which costs the sender of a transaction more money. Learn how to save on fees in the future with UTX Management: Guide: Save Money with UTXO Management

Sidechains & Layer-2 Solutions

• Liquid Network – A Bitcoin sidechain that allows faster and cheaper transactions, but therefore compromises on dezentralisation
• Fedimint & Ecash – Emerging solutions that bring federated smart contracting to Bitcoin while preserving privacy.

Final Thoughts

• Bitcoin smart contracts are simple, secure, and efficient (prioritising safety over complexity)
• Unlike Ethereum, Bitcoin does not support Turing-complete contracts, preventing network congestion and security risks.
• The Lightning Network expand Bitcoin’s smart contract capabilities while keeping the base layer lean.