Woody encroachment is a growing concern in dryland regions, threatening grassland ecosystems and generating complex social-ecological and management challenges. In the Argentine Dry Chaco, this process is particularly pronounced in paleochannel systems, which are ancient riverbeds historically covered by native grasses. Using a multilevel approach combining structural equation models and semi-structured interviews with small-scale campesino producers, we explored how livestock densities (cattle, goats, sheep), fire-use (frequency and return interval), aridity, and protection status influence vegetation cover, and which grassland recovery strategies are suggested by campesinos. We found that aridity was negatively associated with grass cover. At the landscape level, fire frequency is critical for maintaining grasslands. In contrast, at the local level, the role of fire varied with protection status: in protected areas, longer fire return intervals and extensive grazing maintained a mosaic of woodlands and grasslands, whereas in non-protected areas, frequent burning was required to control woody cover driven by fencing and higher livestock densities. Goat density had a strong negative effect on grasslands and a positive association with woodlands, reinforcing feedback on degradation under intensive grazing. Campesino producers recognized fire as a crucial tool for controlling woody encroachment, emphasizing knowledge loss and regulatory challenges. Local knowledge also revealed concerns about water scarcity and fencing, which limits livestock efficiency and promotes woody encroachment. Our findings emphasize that the locally adapted use of fire and grazing, informed by traditional knowledge of campesinos and local partners, is essential for controlling woody encroachment and restoring multifunctional grassland landscapes.