what is the etymology of `loop device`

I believe it is from loopback,

Loopback, or loop-back, refers to the routing of electronic signals, digital data streams, or flows of items back to their source without intentional processing or modification.

It is a loop device because it is backed by a file on a different file-system.

See also Loopback Device,

A Loopback Device is a mechanism used to interpret files as real devices. The main advantage of this method is that all tools used on real disks can be used with a loopback device.