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The Federal Reserve cuts interest rates, the cold and hot of DeFi lending

As soon as the news of the Federal Reserve's interest rate cut came out, almost all cryptocurrency media headlines were cheering: lower capital costs, increased liquidity, and a bull market for the crypto market. In reality, the situation is far more complex than a simple causal chain. The market had already priced in expectations of the rate cut, and we did not see funds immediately flood into BTC and ETH. So, how does the Federal Reserve's monetary policy actually affect the crypto world?

Unlike traditional finance, on-chain lending markets like Aave and Morpho have interest rates dynamically determined by supply and demand rather than by central bank directives. This does not mean that the Federal Reserve's policies are irrelevant to them. On the contrary, the Fed's interest rate cuts provide a macro backdrop for on-chain lending and trigger two contrasting forces. The first force is a short-term counter effect. When the Fed lowers the benchmark interest rate, the risk-free returns in traditional markets, such as treasury bonds and money market funds, also decline. At this point, capital seeking high returns starts looking for new safe havens. This influx of funds may flow into DeFi protocols, pushing up borrowing utilization and causing interest rates for on-chain lending to rise instead of fall. For example, before the Fed announced the rate cut, we had already seen an interesting divergence between the annualized yield of USDC supply on Aave and the overnight financing rate in traditional finance. Funds are pouring in ahead of time, seeking yields unrelated to traditional markets. We can also see this trend from the changes in the borrowing supply yield spread. In the days leading up to the Fed's interest rate cut announcement, the lending-supply yield spread for Aave USDC on Ethereum gradually narrowed. This was due to more funds flowing into the supply pool in pursuit of yields, leading to an increase in APY and, in the short term, narrowing the spread with borrowing rates.

The second force is the long-term direct correlation. This short-term reverse effect is not the whole story. From a medium- to long-term perspective, another force will dominate. When the risk-free interest rate decreases overall, the cost of all alternative lending sources, including cryptocurrencies, will also decrease. Borrowers can obtain loans or refinance at a lower cost, which will generally push down on-chain and off-chain lending rates. The forward yield market of DeFi, Pendle, confirms this well. Pendle allows traders to lock or speculate on future DeFi interest rates. Although its absolute interest rates are much higher than traditional finance, the shape of its forward yield curve is highly similar to that of SOFR. As the market digests expectations of further easing from the Federal Reserve, Pendle's forward yields have also declined. This indicates that even in the crypto market, traders generally expect that as macro policies change, on-chain yields will ultimately show a downward trend.

The impact of the Federal Reserve's interest rate cuts on the crypto market cannot be simply summarized as positive or negative. It triggers a series of complex chain reactions, from the short-term rebound of on-chain yields, to the downward trend of the medium- and long-term interest rate curve, and then to the narrowing of lending spreads. By combining real on-chain data, we can go beyond those vague news headlines and truly understand how macro policies seep into every corner of the crypto world through complex mechanisms. The next time you hear news of the Federal Reserve lowering interest rates, consider exploring on-chain data platforms; you will discover a story that is richer and more interesting than the headlines.