Mapping Microscopic and Systemic Risks in TradFi and DeFi: a literature review

2025-08-16

AI Summary

This study investigates the formation mechanisms, propagation pathways, and cross-system spillover effects of systemic risk in traditional finance (TradFi) and decentralized finance (DeFi). Employing a systematic literature review and conceptual modeling, it integrates financial system dynamics, network-based interdependence analysis, and comparative institutional–technological architecture assessment to develop the first cross-ecosystem comparative risk framework. Methodologically, it introduces the novel concept of “cross-domain risk spillover” (crosstagion), uncovering bidirectional risk transmission; constructs a risk mapping model to characterize divergent evolutions of leverage cycles, liquidity crises, and smart contract vulnerabilities across TradFi and DeFi. The analysis systematically differentiates micro-level and systemic risk commonalities and heterogeneities, yielding a theoretical toolkit for regulators and market participants to identify cross-domain transmission channels—and thereby advancing a paradigm shift toward integrated hybrid financial risk governance.

Technology Category

• Application Domains: Humanities & Computational Social Science
• Planning, Routing, and Scheduling: Optimization of Spatio-temporal Systems
• Multiagent Systems: Multiagent Systems under Uncertainty

Application Category

• Systems and Infrastructure for Web, Mobile and WoT: Web applications in cross-disciplinary domains and verticals such as mixed reality, smart cities, and digital health
• Security and Privacy: Blockchains and distributed ledgers
• Social Networks and Social Media: Generative AI / large language models and their impact on social systems

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.

Problem

• Analyzing systemic risk formation in TradFi and DeFi
• Comparing risk propagation mechanisms in TradFi vs DeFi
• Exploring bidirectional spillover effects between TradFi and DeFi

Innovation

• Comparative framework for TradFi and DeFi risks
• Conceptual model for systemic risk formation
• Crosstagion concept for bidirectional risk spillover