The Fed lowered interest rates this week and hinted at further easing of policies in the future. Almost all mainstream crypto news headlines convey the same message: lower capital costs → increased liquidity → bullish on crypto assets.

But the reality is more complex. The market has long priced in expectations of a rate cut, and the inflow of funds into BTC and ETH has not seen an immediate surge. Therefore, we should not stay on the surface level, but instead study how the rate cut affects a part of DeFi—lending.
On-chain lending markets like Aave and Morpho dynamically price risk, rather than relying on directives from regulatory agencies. However, the Fed's policies provide important references for this context.

When the Fed lowers interest rates, two opposing forces are at work:
1) Reverse effect: Fed interest rates drop → on-chain yields rise, as people seek uncorrelated assets.
As capital seeks returns beyond traditional government bonds and money market funds, it may flow into DeFi, thereby driving up utilization and increasing on-chain interest rates. By comparing the Supply APY of USDC on Aave with the SOFR (Secured Overnight Financing Rate), we can observe this trend gradually emerging before the Fed's rate cut in September.

We also see this situation occurring as the DeFi lending-supply yield spread decreases. Taking Aave's USDC lending situation on Ethereum as an example, in the days leading up to the Fed's interest rate cut announcement, the lending-supply yield spread gradually narrowed. This is mainly due to more funds chasing yields, supporting a short-term reverse effect.

2) Direct correlation: Fed interest rates drop → On-chain yields also drop, as alternative liquidity sources become cheaper. As risk-free rates decline, the costs of alternative liquidity sources such as Crypto Assets also decrease. Borrowers can refinance or leverage at a lower cost, thereby pushing down on-chain and off-chain lending rates. This dynamic usually persists in the medium to long term.