At the heart of our global financial system lies a complex network of intermediaries and institutions that ensure money moves from one place to another. Known as the global settlement layer, this framework involves multiple entities: central banks, commercial banks, clearinghouses, and payment processor —all working together to facilitate transactions across borders and within nations.

While this system has functioned for decades, it’s slow, opaque, and riddled with inefficiencies. Enter decentralized finance (DeFi): a blockchain-based alternative that not only simplifies the global settlement process but also makes it transparent and accessible to everyone.

How Transactions Work in the Traditional Financial System

The traditional financial system is a multi-layered structure designed to ensure that money moves securely and efficiently between individuals, businesses, and institutions. Here's how it works:

1. Local Transactions: The Bank's Ledger

When individuals or businesses conduct transactions within the same bank, the process occurs entirely on the bank’s internal ledger:

Example: Alice sends $100 to Bob, and both have accounts at the same bank. The bank debits $100 from Alice's account and credits $100 to Bob's account.

Behind the Scenes: This transaction never leaves the bank's ledger. It's simply an adjustment of internal records.

For these types of transactions, the process is fast and involves minimal costs because no external entities are involved.

2. Between Banks: Settlement at the Central Bank

When a transaction involves two different banks, the process becomes more complex:

Example: Alice banks with Bank A, and Bob banks with Bank B. Alice wants to send Bob $100.

Step 1: Messaging System

Alice’s bank (Bank A) uses a system like SWIFT to communicate with Bob’s bank (Bank B), instructing it to credit $100 to Bob. SWIFT only sends messages; it doesn’t handle the actual transfer of funds.

Step 2: Clearing Between Banks

Bank A doesn’t directly send $100 to Bank B. Instead, both banks have reserve accounts at the central bank (e.g., the Federal Reserve in the U.S.). The central bank debits $100 from Bank A’s reserve account and credits $100 to Bank B’s reserve account.

This settlement process ensures that banks reconcile their liabilities without physically moving money. However, it requires significant coordination, often leading to delays and fees.

3. Cross-Border Transactions: The Global Settlement Layer

When transactions cross national borders, the process becomes even more layered:

Example: Alice in the U.S. sends $100 to Bob in Germany.

Step 1: Correspondent Banking Network

Bank A (Alice’s bank) in the U.S. doesn’t have a direct relationship with Bank B (Bob’s bank) in Germany. Instead, it relies on correspondent banks to act as intermediaries.

Step 2: Currency Conversion

If Alice sends dollars and Bob needs euros, the correspondent banks handle the currency exchange, often at high fees.

Step 3: Settlement on the Global Ledger

Once all intermediary steps are completed, the transaction is finalized. This involves reconciliation across central banks (e.g., the Federal Reserve and the European Central Bank) to ensure reserves are adjusted appropriately.

This system, while functional, is slow, opaque, and expensive, especially for smaller transactions. Settlement can take several days and incur significant fees due to the multiple intermediaries involved.

How DeFi Simplifies and Improves the Process

DeFi, or decentralized finance, eliminates the need for many of these layers by using blockchain technology. Here’s how it works differently:

1. Peer-to-Peer Transactions on the Blockchain

In DeFi, individuals transact directly with each other using digital wallets and blockchain networks:

Example: Alice wants to send $100 worth of stable-coins to Bob.

How It Works:

Alice uses her digital wallet to send stable-coins directly to Bob’s wallet. The blockchain processes the transaction, updating the global, shared ledger.

Unlike traditional systems, this process is instantaneous, doesn’t require intermediaries, and costs a fraction of traditional fees.

2. A Single Global Ledger

The blockchain serves as a unified global ledger that records all transactions transparently:

No Local Ledgers: There’s no need for individual banks to maintain separate ledgers. Every transaction is recorded on a single, decentralized ledger that anyone can verify.

Real-Time Settlement: Transactions are settled in real time, eliminating delays caused by the reconciliation process in traditional banking.

Cross-Border Simplicity: Since blockchains are global, there’s no need for correspondent banks or currency conversion. Participants transact directly, using cryptocurrencies or stable-coins that are universally accepted.

3. Transparency and Trust

In the traditional system, users have little insight into the flow of their money. With DeFi:

Transparency: Every transaction is visible on the blockchain, ensuring that fees, processing times, and balances are clear to all participants.

Trustless Operation: DeFi relies on smart contracts—self-executing agreements coded on the blockchain. These contracts eliminate the need for trust in third parties, as the code ensures that terms are automatically enforced.

The Future of Financial Transactions

The global settlement layer as we know it is outdated. It’s slow, costly, and inaccessible to billions of people. DeFi offers a new paradigm: a unified, transparent, and efficient system where individuals can transact directly, bypassing the complexities of traditional finance.

As blockchain adoption grows, the inefficiencies of the current system will become increasingly difficult to justify. The future of finance isn’t just decentralized—it’s simpler, fairer, and more accessible.