Many people eventually realize that Smith is able to be deleted because of the fact that Smith essentially "returns to the Source" by copying over Neo when Neo is plugged directly into the Source (see Matrix System: The Source, Creation and Deletion section). But this is only half of the story, and it is definitely the lesser half. The other half is even more brilliant.
Before Smith copies over Neo, Neo does something that most people completely miss: Neo decides to allow himself to be deleted. He completely surrenders himself to whatever will happen to him: "You were right, Smith. You were always right. It was inevitable." We already know that the system would like to delete Neo since Neo is technically an exile (remember, that's how Neo got into Mobil Avenue in the first place - see Neo: In Mobil Avenue). When Smith copies over Neo, Smith inherits Neo's decision for deletion! In other words, Smith was "tricked" into choosing deletion because he took over an exile who already made that irrational choice. Smith inherits qualities and abilities of programs and people he takes over, so certainly he would also inherit consequences of their previous decisions.When Neo gives himself up, not only does he fulfill his purpose of cancelling out rejection within the Matrix, he gives the machines the only key that can be used to destroy Smith. Only Neo could have accomplished this, because Neo needed to be:
So, Smith's mere connection to the Source through Neo-Smith was not enough to get Smith deleted: deletion had to be chosen. If all the Smiths were merely "connected" to the Source in the end (without Neo's choice preceding it), then all the Smiths would just be dumped into Mobil Avenue as exiles (and probably get right back into the Matrix if one of them is Trainman-Smith). Remember, even though Smith is a virus, he is still an exile who can choose not to be deleted over and over again, if necessary.
Just as the system began to delete Neo-Smith, Oracle-Smith said, "Oh, no, no, no. No, it's not fair." Now we know why: Oracle-Smith doesn't think it's fair that he has to share Neo's sacrifice just because Neo chose it for himself.
A reader of this website named Riley Stimpson pointed out something else that doesn't add up completely for reasons I'll mention soon, but I think it is still worth quoting because it's so interesting:
Near the end of Matrix Revolutions, Smith had taken over everything within the Matrix. He had removed all anomalies except one, the anomaly of rejection. My theory is that when Neo chose to be deleted by Smith, allowing temporary dissemination of his code, Smith fulfilled his ultimate purpose: to remove all anomalies within the Matrix. With all anomalies gone, Smith had no choice but to be deleted. He had always been bound by purpose, and since he no longer had a purpose, there was nothing driving him to disobey anymore.
This would give additional meaning to Smith's "Oh, no, no, no. No, it's not fair." He didn't want to be deleted, but he not longer had a purpose. He had no choice but to allow himself to be deleted. He isn't human, he doesn't have free will, and he surely doesn't believe that is fair.
In order for anomalies to be removed via temporary dissemination of code, Neo had to be connected to the source. This is why he had to go to Machine City.
The only problem with this is something the Oracle says in M3: "Very soon he's [Smith] going to have the power to destroy this world [the Matrix], but I believe he won't stop there; he can't. He won't stop until there's nothing left at all [start infecting Machine City]." When Smith overtook Neo, he finally destroyed the entire world (the Matrix) by destroying The One (the last component of the Matrix System that had not yet been infected), and yet he was unable to proceed to Machine City, which either makes the Oracle wrong (she's never wrong) or means the conditions are different than what she described earlier. What condition is different? Neo's irrational decision to sacrifice himself. Had Smith been able to overtake Neo against his will, Smith would have been able to move on to infecting the Source and everything beyond that, just as the Oracle said he would.
Smith was fooled by the fact that Neo did not understand his own decision to give himself up, and only because of this, Oracle-Smith could not see his own defeat in the future. But Neo also fooled Smith in another way: Smith did not realize Neo was plugged directly into the Source. Neo’s code does not appear gold to Smith even though Neo enters the Matrix through Machine City. Code color does not indicate where a human or program resides in the real world – it simply indicates whether it is a human or machine (when Neo saw the gold code of Seraph, he guessed correctly that the code identified him as a machine).
Also, since Oracle-Smith does not know that Niobe will give Neo her ship, Oracle-Smith thinks Neo is merely hacking in as usual. The Oracle believes in things she doesn’t see, while Smith only believes what he knows.
The Oracle is just as responsible for saving Zion as Neo is, since she caused Smith to utter words to Neo that would most likely persuade Neo to make the choice he needed to make. She caused Smith to say, "Everything that has a beginning has an end, Neo" (see Oracle: Baking Cookies). We know she caused it because she said the same thing to Neo the last time she saw him. Not only that, Smith didn't even know what he said right after he said it, and he asks Neo, "Is it over?". It appears that Neo would have fought to his death had he not been prompted by the Oracle to sacrifice himself.
When Neo's predecessors fulfilled part of their purpose as the One, each of them cancelled out rejection which had built up within the Matrix. Their one choice for themselves was applied to nullify millions of rejections within the Matrix.
Ironically, when Neo fulfilled his purpose of cancelling out rejection, Neo's choice for deletion applied to one more entity: Smith. The first result of Neo's choice was all of the exploding Smiths. The second result of Neo's choice was the ability to restart the next Matrix version, because Neo cancelled out rejection from the previous version. Neo's choice for sacrifice carried twice the impact of his predecessors.
Smith could control every rule in the Matrix, while Neo could break every rule. In the end, Smith and Neo combine to form an entity that can not only control but break every rule that the Matrix is built upon. What else is there inside the Matrix besides these programming rules? Neo-Smith is essentially the code for the entire Matrix.
There is another theory that says Neo and Smith (opposites) cancelled each other out when Smith took over Neo, and this is the sole reason Smith was defeated. For my thoughts about this, see Debunked: Cancelling Opposites.
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