Paper: arXiv 2508.12007

Authors: Sabrina Aufiero, Silvia Bartolucci, Fabio Caccioli, Pierpaolo Vivo

Abstract

This work explores the formation and propagation of systemic risks across traditional finance (TradFi) and decentralized finance (DeFi), offering a comparative framework that bridges these two increasingly interconnected ecosystems. We propose a conceptual model for systemic risk formation in TradFi, grounded in well-established mechanisms such as leverage cycles, liquidity crises, and interconnected institutional exposures. Extending this analysis to DeFi, we identify unique structural and technological characteristics - such as composability, smart contract vulnerabilities, and algorithm-driven mechanisms - that shape the emergence and transmission of risks within decentralized systems. Through a conceptual mapping, we highlight risks with similar foundations (e.g., trading vulnerabilities, liquidity shocks), while emphasizing how these risks manifest and propagate differently due to the contrasting architectures of TradFi and DeFi. Furthermore, we introduce the concept of crosstagion, a bidirectional process where instability in DeFi can spill over into TradFi, and vice versa. We illustrate how disruptions such as liquidity crises, regulatory actions, or political developments can cascade across these systems, leveraging their growing interdependence. By analyzing this mutual dynamics, we highlight the importance of understanding systemic risks not only within TradFi and DeFi individually, but also at their intersection. Our findings contribute to the evolving discourse on risk management in a hybrid financial ecosystem, offering insights for policymakers, regulators, and financial stakeholders navigating this complex landscape.

Complexity vs Empirical Score

  • Math Complexity: 2.0/10
  • Empirical Rigor: 3.0/10
  • Quadrant: Philosophers — conceptual discussion, limited math and data

Why this score: This paper offers a comprehensive qualitative and conceptual literature review bridging systemic risk mechanisms in TradFi and DeFi. While it introduces useful comparative frameworks and the concept of ‘crosstagion’, it relies entirely on narrative synthesis rather than quantitative modeling, mathematical derivations, or empirical data testing.

Research Flowchart

  flowchart TD
    A[Research Goal: Map & Compare Systemic Risks in TradFi vs. DeFi] --> B[Methodology: Literature Review & Conceptual Mapping]
    B --> C[Inputs: TradFi Risk Frameworks & DeFi Technical Characteristics]
    C --> D[Comparative Analysis: Structural Vulnerabilities vs. Algorithmic/Composability Risks]
    D --> E[Cross-Ecosystem Dynamics: Model Crosstagion Spillover Mechanisms]
    E --> F[Outcomes: Unified Systemic Risk Framework & Policy/Risk Management Insights]