Carbon dots (CDs) are optically active carbon-based nanomaterials. These nanomaterials can change their light emission properties in response to various external stimuli such as pH, temperature, pressure, and light. The CD’s remarkable stimuli-responsive smart material properties have recently stimulated massive research interest for their exploitation to develop various sensor platforms. Herein, an effort has been made to review the major advances made on CDs, focusing mainly on its smart material attributes and linked applications. Since the CD’s material properties are largely linked to their synthesis approaches, various synthesis methods, including surface passivation and functionalization of CDs and the mechanisms reported so far in their photophysical properties, are also delineated in this review. Finally, the challenges of using CDs and the scope for their further improvement as an optical signal transducer to expand their application horizon for developing analytical platforms have been discussed.