Stem cells interact with surrounding stromal cells (or niche) via signaling pathways to precisely balance stem cell self-renewal and differentiation. However, little is known about how niche signals are transduced dynamically and differentially to stem cells and their intermediate progeny and how the fate switch of stem cell to differentiating cell is initiated. The Drosophila ovarian germline stem cells (GSCs) have provided a heuristic model for studying the stem cell and niche interaction. Previous studies demonstrated that the niche-dependent BMP signaling is essential for GSC self-renewal via silencing bam transcription in GSCs. We recently revealed that the Fused (Fu)/Smurf complex degrades the BMP type I receptor Tkv allowing for bam expression in differentiating cystoblasts (CBs). However, how the Fu is differentially regulated in GSCs and CBs remains unclear. Here we report that a niche-dependent feedback loop involving Tkv and Fu produces a steep gradient of BMP activity and determines GSC fate. Importantly, we show that Fu and graded BMP activity dynamically develop within an intermediate cell, the precursor of CBs, during GSC-to-CB transition. Our mathematic modeling reveals a bistable behavior of the feedback-loop system in controlling the bam transcriptional on/off switch and determining GSC fate.