Today we are going to take a look at what happened with Iron Finance, and why the events that played out mirror a bank run in the traditional finance world.
For the usual disclosure, I am not a financial advisor, I don’t even work in finance at all. My day job is as a telecommunications software engineer. Treat everything you read here as some educational resources and not financial advice.
Preface
To start, I am not writing about this to knock the developers, or to scare people away from Decentralized Finance (DeFi), but it is important for people to understand the failures as much as the successes for a couple of reasons. Not only does it help illustrate the risks involved in this space, but it also helps inform the next generation of applications so that they can learn from these incidents, and can try and find solutions to avoid them in the future.
I’m also purposely not going to link to their website or tokens as I normally do on an article, because I think for dead projects like this, it’s better to not drive any additional traffic towards them.
What Is Iron Finance
Iron Finance is a Decentralized Finance (DeFi) protocol that was launched on Binance Smart Chain (BSC) in March of 2021, with the goal of creating a partially collateralized algorithmic stablecoin. This is of course not an easy venture to undertake, and most projects that do try, fail or struggle to maintain their peg to the US dollar.
Iron Finance wanted to avoid the common shortfalls of stablecoins, which are either centralization of the custody of the collateral backing the crypto, like with cryptos such as Tether (USDT), or the need to overcollateralize like with Dai (DAI).
They created the IRON token, fueled by their underlying ecosystem, which had some early hiccups where it would lose it’s peg for a short time, and some DeFi hacks that had affected some of it’s users, but by all accounts it managed to be a rather successful launch. This may have led to a false sense of security that helped fuel the later events.
How It Worked
The Iron Finance protocol was built around two types of protocols, it’s own native tokens on the given blockchain, as well as it’s partially collateralized stablecoin, the IRON token. They had liquidity pools on each network pairing their native tokens with a standard stablecoin.
On Binance Smart Chain (BSC), it had it’s STEEL token, paired with Binance USD (BUSD) , and on Polygon (MATIC), they had their TITAN token, which were paired with USD Coin (USDC). The idea was that with these pairings, they could lower the amount of needed collateral over time, and therefore make the protocol much more capital efficient than most.
To keep the soft peg on the IRON token, it had a mechanism for minting and redeeming them that relied on economic incentives and arbitrageurs in order to keep the price stable. Whenever the price of the token fell below $1.00, anyone was able to redeem them for about $1.00 worth of value, paid out in the stablecoin and native token of whatever network the transaction was done on. The redeemed IRON tokens would be burned.
Whenever the price was above $1.00, anyone could mint new IRON tokens for about $1.00 in value paid in another ratio, which could then be sold on the open market. These two mechanics would control the supply, and help enforce the soft peg of the price.
There was some magic math involved in the minting and redeeming process, the target collateral ratio, and the effective collateral ratio. These would determine how much of the stablecoin versus how much of the native token was needed to maintain the price, and this ratio was controlled by the time weighted average of the price of the IRON token. If the ratio was at 75%, then it would be 75% in stablecoin and 25% in the native token.
If the average price of the token was higher than $1.00, the ratio would go down, and if the price was lower, than the ratio would go up. This was supposed to be the mechanic that would allow lowering the amount of collateral over time to increase the efficiency.
Another thing to note, whenever someone minted IRON tokens, the native token portion of the collateral would be burned, and when IRON is redeemed, new native tokens were minted to pay the user back their collateral.
It all seems quite complicated, but to boil it down, through the users doing the acts of minting and redeeming the IRON tokens, for their own economic profits, the supply of both the IRON and the native tokens would be controlled through minting and burning them as needed,
What Happened
Now we will walk through the events that led up to the total collapse of the protocol, and the specifics that caused it to happen.
In May of 2021, Iron Finance expanded out to the Polygon (MATIC) network, which fueled a lot of interest in the protocol, leading to some pretty large growth. This drove the total locked value within the protocol to up over $2 billion dollars before the collapse. The price of their TITAN token, which was their base token on the Polygon (MATIC) network, also rose from $10 to $64 in the weeks leading up to the crash.
This growth was fueled by very high return rates on their yield farms, and as I’ve said in plenty of posts before, the greater the rewards you get back, the higher the risk you have for putting your money into it. This of course was no exception. The rewards were up to 500% on stablecoin pairs, while you could see up to 1700% on the more volatile pools.
On 16 Jun 2021, the protocol experienced what can best be described as a significant bank run, which crashed the price of TITAN to zero and caused a lot of people to experience significant losses in the process.
What kicked everything off was a large number of whales started withdrawing their liquidity from the pool, and then converting the native tokens they received back into IRON, which they then turned around and sold into the stablecoin using the liquidity pools.
This unpegging caused a little bit of panic in the native token holders, and caused them to sell off a large portion of the assets, plunging the price. For TITAN, that drop went from $64 down to about $30 in a matter of hours. Within a few hours, both the price of the native tokens had bounced back, and the IRON token had reacquired its peg.
Later that same day, a few whales pulled the same maneuver, which caused an even bigger panic in the market, and another major sell off happened. This time however, due to the major amount of traffic, the oracle service that was used to generate the time weighted average price that the entire protocol relied on, started to report stale prices that were higher than the actual market price.
Because this oracle was used to determine the ratios and thus how many of the native tokens to issue, it’s failure created a negative feedback loop within the protocol, as users were able to get more native tokens than they should have been able to get, to sell on the market. This of course caused a death dive in the price of the tokens, and essentially killed the protocol where it stood.
The team behind Iron Finance eventually managed to get the users some of the value back, but they all took very significant losses in the process. This included everyone providing liquidity, because when the price of one token in a liquidity pair crashes down to basically zero, impermanent loss basically wipes out the value. All the stablecoin would basically have been removed from the pool as people sold the native tokens, so removing your liquidity would net you a bunch of worthless tokens.
While Iron Finance has a pretty good protocol, and a plan that should have worked, there were a few key flaws in the platform, and coupled with both human greed, and fear, plus the failure of a technology that everything relied on, caused a perfect storm for what is being called the first large scale bank run in the crypto space.
It did not have sufficient capital to pay for the withdraws, because the native tokens, which were being used for about 25% of the collateral, crashed to being worthless. And if people had not panic sold the price to nothing, the protocol would have recovered itself, as it had in the past, but the combination of technological failure and human emotion pushed it into the depths far too deep to make it back to the surface.
Conclusion
I think Iron Finance had some pretty good ideas in their protocol, but the few problems it had combined into a significant enough one to kneecap the whole thing, but it managed to get pretty close to the holy grail of an algorithmically controlled stablecoin. The first people to crack that nut and make it happen are going to become very famous, and likely quite wealthy off the technology, but nobody has managed to pull it off as of yet.
This is also a prime example of, no matter how much hype, no matter how good the protocol is, no matter how great it all seems, everything in the crypto space is a risk, and you should never put in more than you are willing to have crash to zero, because if big rich guys like Mark Cuban can get rekt by something like this, obviously it can happen to any of us non-experts out there. It’s dangerous, but also fun, out there, so watch your ass and do your own research!
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Flash Loans
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Impermanent Loss
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Originally Posted On My Website: https://ninjawingnut.xyz/2021/07/16/iron-finance/
