What functions a financial system performs
Five functions every financial system must perform — and the question of who performs each of them in DeFi.
This lesson has had no expert review. It was written for this platform and against the evidence it cites; nobody has gone through it independently.
Learning objectives
- You can name five core functions of a financial system.
- You can say, for each function, who performs it in a DeFi protocol — or that no one does.
Check your prior knowledge
Answer these for yourself before reading on. Wherever you hesitate is where this lesson pays off.
- What distinguishes a bank from an exchange?
- What does it mean for a trade to be “settled”?
- Who bears the risk when a counterparty fails to deliver?
Core concept
Five functions, independent of the technology
A financial system has to do five things, whether it is made of banks or of contracts: channel capital between savers and users, settle payments, hold assets in custody, form prices and transfer risk. Knowing those functions lets you ask of any new financial product which of them it performs.
In DeFi the functions do not disappear — they change hands
A lending market without a bank still channels capital; it replaces creditworthiness assessment with overcollateralization. A trading venue without an order book still forms prices; it does so through a formula rather than through bids and offers in a book. Custody sits with the user instead of with a custodian. The function remains; the question “who is liable when it fails” is answered anew each time.
The function most often overlooked
Risk transfer is the function for which DeFi least often has a nameable bearer. In the traditional system, behind a default stands a deposit guarantee, a clearing house or an insurer. In a protocol, what stands there is a mechanism: a reserve, a liquidation procedure, a distribution rule. A mechanism can work — but it is not someone you can make a claim against.
Definitions
- Financial intermediation
- Channeling capital between those who supply it and those who use it — including assessing whether that use is sound.
- Settlement
- The point at which a trade is finally performed and can no longer be unwound.
- Custody in the glossary
- Holding assets on behalf of another, including liability for their loss.
Model
Intermediation → bank / lending protocol with overcollateralization
Payment & settlement → payment system / chain finality
Custody → custodian / keys held by the user
Price formation → exchange with order book / formula in the contract
Risk transfer → insurer, clearing house / mechanism with no addressee
Worked example
The same function, two bearers
- Function
- Settlement
- Traditional
- T+2, clearing house as counterparty
- On-chain
- finality after n blocks, no clearing house
Both paths end in a performed trade. What differs is duration, reversibility, and the answer to who answers for an error.
Traditional: two days, a clearing house is liable. On-chain: minutes, no one is liable.
Reading: Faster is not the same as better. The time saved is paid for with the loss of an authority able to correct a mistake.
Retrieval
Exercise on real data
Open any lending market and note which of the five functions you can find in the fields shown — and which you cannot.
Open a lending market in the Explorer →Application
A provider describes its product as a “savings account paying 8 %”. Which three questions do you ask first?
Institutional reading
- Bank
- Which of these functions does the institution perform itself today, and which would it hand over in a DeFi integration?
- Advisory
- Which of the five functions does the client tacitly expect without asking?
Key takeaways
- The functions of a financial system do not vanish in DeFi — they change hands.
- The most useful question about any product is: which function does it perform, and who is liable when it fails?
- Risk transfer is the function where a nameable bearer is most often missing.
Evidence
- EVD-2026-0001
Electronic Markets (Springer) — A multivocal literature review of decentralized finance: Current knowledge and future research avenues