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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.

Core concept

Fact

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.

Interpretation

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.

Risk

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

  1. Intermediation → bank / lending protocol with overcollateralization

  2. Payment & settlement → payment system / chain finality

  3. Custody → custodian / keys held by the user

  4. Price formation → exchange with order book / formula in the contract

  5. Risk transfer → insurer, clearing house / mechanism with no addressee

The five functions and their bearers — The arrow means “is performed by”, not “is equivalent to”.

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

A lending protocol does without a credit assessment. What does it replace it with?
Which of the five functions typically has no nameable bearer in a pure DeFi protocol?

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

Evidence