So what was the first large  scale bank run in DeFi all about?  

Why is it so hard to create a working  algorithmic stablecoin? And what can  

we learn from the IronFinance fiasco? You’ll  find answers to these questions in this video.

Before we begin, if you want to learn more about  decentralized finance and the technology behind  

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IronFinance initially launched on  Binance Smart Chain in March 2021  

and aimed at creating an ecosystem for a  partially collateralized algorithmic stablecoin.

As we know, building algorithmic stablecoins is  hard. Most projects either completely fail or end  

up in a no man's land by struggling to maintain  their peg to the US Dollar. Because of this,  

building an algorithmic stablecoin has  become one of the holy grails in DeFi.

Achieving it would clearly revolutionize  the DeFi space as we know it today.

The current ecosystem relies heavily on  stablecoins that come with major trade-offs. They  

maintain their peg to the US Dollar at the cost  of either centralization or capital inefficiency.

For example, the custody of USDC or USDT  is fully centralized. On the flip side,  

stablecoins like DAI or RAI require a lot of  collateral which makes them capital inefficient.

IronFinance tried to address  these problems by creating a  

partially collateralized stablecoin - IRON.

Despite a few hiccups along the road, such as  short periods of time when IRON unpegged from USD  

or when ValueDeFi exploits affected  some of the IronFinance users,  

the protocol kept marching forward.

In retrospect, recovering from these issues most  likely built a false level of confidence in the  

protocol design as its users thought they  were dealing with a “battle-tested” project.

In May 2021 IronFinance expanded to Polygon  and started gaining more and more traction.

Total value locked in the protocol quickly  went from millions to billions of dollars,  

surpassing 2 billion before the final collapse.  The value of TITAN - protocol’s native token on  

Polygon - went from $10 to $64 just in  the last week leading to the bank run.

This parabolic growth was mostly driven  by extremely high yield farming rewards  

and subsequent high demand for  both the TITAN and the IRON tokens.  

Yield farmers were able to benefit from  around 500% APR on stablecoin pairs:  

IRON/USDC and around 1700% APR on  more volatile pairs like TITAN/MATIC.

To add even more fuel to this parabolic growth,  

IronFinance was mentioned by a famous  investor - Mark Cuban - in his blog post.  

This further legitimised the project  and brought even more attention to it.

On the 16th of June 2021, the protocol  experienced a massive bank run that crashed  

the TITAN price to 0 and resulted in thousands  of people experiencing major financial losses.

Before we start unfolding all of the events  that led to the collapse of IronFinance,  

let’s try to understand  how the protocol was built.

It’s worth noting that reviewing the design  of projects, including the ones that failed,  

is important as it allows us  to better understand what works  

and what doesn’t work in DeFi. It also  makes it easier to assess new protocols  

that very often reuse a lot of elements  of the already existing systems.

The IronFinance protocol was  designed around 3 types of tokens: 

Its own partially collateralized stablecoin - IRON  that should maintain a soft peg to the US Dollar, 

Its own token: TITAN on Polygon and STEEL on BSC, 

an established stablecoin used as  collateral: USDC on Polygon and BUSD on BSC

The combination of USDC and TITAN on Polygon  or BUSD and STEEL on BSC was supposed to  

allow the protocol to decrease the amount of  stablecoin collateral over time and in turn,  

making IRON partially collateralized  leading to a greater capital efficiency.

The protocol, although using  different tokens on Polygon and BSC,  

worked in an analogous way on both  platforms so in order to simplify  

this video going further I’m going to skip the  BSC tokens BUSD and STEEL in the explanation.

In order to achieve price stability of  the IRON token, the protocol introduced  

a mechanism for minting and redeeming IRON that  relied on market incentives and arbitrageurs.

Whenever the price of the IRON token was  less than $1, anyone could purchase it on  

the open market and redeem it for approximately  $1 worth of value paid in a mix of USDC and TITAN.

Whenever the price of the IRON  token was greater than $1,  

anyone could mint new IRON tokens for  approximately $1 worth of USDC and TITAN  

and sell the freshly minted IRON tokens on the  open market, driving the price of IRON back to $1.

To understand the process of minting and  redeeming better, we have to introduce the  

concept of Target Collateral Ratio (TCR)  and Effective Collateral Ratio (ECR).

Target Collateral Ratio is  used by the minting function  

to determine the ratio between USDC  and TITAN required to mint IRON.

As an example, let’s say the  TCR is at 75%. In this case, 75%  

of collateral needed to mint IRON would come  from USDC and 25% would come from TITAN.

The protocol started at 100% TCR and  gradually lowered the TCR over time.

TCR can increase or decrease depending on the  IRON price. On one hand, if the time-weighted  

average price of IRON is greater than  $1, TCR is lowered. On the other hand,  

if the time-weighted average price of IRON  is less than $1, the TCR is increased.

Effective Collateral Ratio is used by  the redeeming mechanism to determine the  

ratio between USDC and TITAN when  redeeming IRON. ECR is calculated  

as current USDC collateral  divided by the total IRON supply.

If TCR is lower than ECR, the protocol  has excess collateral. On the flip side,  

if TCR is higher than ECR it means  the protocol is undercollateralized.

As an example, if the ECR is at 75%,  

each time IRON is redeemed the user would get 75%  of their collateral back in USDC and 25% in TITAN.

What is important is that every  time someone mints IRON the TITAN  

portion of collateral is burned. If someone  redeems IRON, new TITAN tokens are minted.

As we can see, the whole mechanism, although a  bit complicated, should work - at least in theory.

Now, let’s see how the events leading  to the collapse of IronFinance unfolded.

But before we do this, Finematics is participating  in Round 10 of Gitcoin Grants where even the  

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Let’s get back to the video.

Around 10 am UTC on 16th June 2021, the  team behind the protocol noticed that a few  

larger liquidity providers a.k.a “whales” started  removing liquidity from IRON/USDC and then started  

selling their TITAN to IRON. Instead of redeeming  IRON, they sold it directly to USDC via liquidity  

pools. This caused the IRON price to unpeg from  the value of the US Dollar. This in turn spooked  

the TITAN holders who started selling their TITAN  causing the token price to drop from around $65  

to $30 in approx 2 hours. The TITAN price later  came back to $52 and IRON fully recovered its peg.

This event, although quite severe, wasn’t that  unusual considering that the protocol had a  

history of native tokens sharply dropping in value  and IRON unpegging for a short period of time.

Later on the same day, a few whales started  selling again. This time it was different. The  

market panicked and users started redeeming  IRON and selling their TITAN in masses.  

Because of the extremely quick  and sharp drop in the TITAN price,  

the time-weighted price oracle  used for reporting TITAN prices  

started reporting stale prices that were still  higher than the actual market price of TITAN.

This created a negative feedback loop as  the price oracle was used to determine  

the number of TITAN tokens that have  to be printed while redeeming IRON.

Because IRON was trading off-peg at under $1,  

the users could buy IRON, for let’s say  $0.90 and redeem it for $0.75 in USDC  

and $0.25 in TITAN and sell TITAN immediately.  This situation created a death spiral for TITAN  

that drove its price to pretty much 0 as  the lower the TITAN price was the more  

TITAN tokens would have to be printed to account  for the correct amount of the redeemed capital.

The TITAN price hitting almost 0 exposed  another flaw in the protocol - users being  

unable to redeem their IRON tokens. This  was later fixed by the team and users were  

able to recover around $0.75 worth of  USDC collateral from their IRON tokens.

Unfortunately, TITAN holders didn’t  get away with “only” a 25% haircut and  

instead took heavy losses. This also  included TITAN liquidity providers.  

This is because when one token in a 50/50  liquidity pool goes to 0 the impermanent  

loss can reach pretty much 100%. Liquidity  providers end up losing both tokens in the pool  

as the non-TITAN token is sold out for TITAN  that keeps going lower and lower in value.

This situation exposed a major  flaw in the IronFinance mechanism  

that resulted in what we can call the  first large scale bank run in DeFi.

Similarly to banks with fractional-reserve  systems, where there are not enough funds  

to cover all depositors at any one time, the  IronFinance protocol didn’t have enough collateral  

to cover all minted IRON. At least  not when the TITAN token used as 25%  

of the overall collateral became  worthless in a matter of minutes.

The IronFinance fiasco also  shows us why DeFi protocols  

shouldn’t fully rely on human coordination,  especially when under certain circumstances  

incentives work against the protocol. In theory,  if people just stopped selling TITAN for a short  

period of time, the system would recover as it  had previously done in the past. In practice,  

most market participants are driven by making a  profit and the arbitrage opportunity present in  

the protocol caused them to fully  take advantage of this situation.  

This is also why all DeFi protocols should  always account for the worst-case scenario.

As with most major protocol failures in DeFi,  there are always some lessons to be learned. 

In the case of IronFinance, there  are a few important takeaways.

First of all, we always have to consider what  would happen to the protocol in the worst-case  

scenario. This usually involves one of the tokens  used in the protocol sharply losing its value.

What happens when the protocol stops  expanding and starts contracting?  

What if the contraction is  way quicker than expansion?

Another important element  of the protocol design that  

always has to be fully understood  is the usage of price oracles.  

Could they report stale prices or get manipulated  by flash loan attacks? If so, what basic protocol  

mechanisms rely on these oracles and how would  they behave when the oracle is compromised.

Next lesson, providing liquidity in a pool  where at least 1 asset can drop to 0 means  

that we can lose pretty much all of our capital,  even if the second token doesn’t lose any value.

Another lesson, following  celebrities and their investments  

might be risky. With great power comes  great responsibility and unfortunately,  

even a single mention of a certain protocol or a  token can cause people to invest in something they  

don’t fully understand - don’t be that person and  always make sure you do your own due diligence.

One good indicator of high-risk protocols  is extremely high APR in yield farming.  

If something looks too good to be true there are  usually some risks that have to be accounted for.

Last but not least, building algorithmic  stablecoins is hard. I hope one day we can  

see a fully functioning algorithmic stablecoin  competing in size with USDT or USDC, but this  

will most likely take a bit of time and hundreds  of failed attempts. If you want to become an early  

adopter of such a coin it’s great, but keep  in mind that the numbers are not on your side.

So what’s next when it comes to  IronFinance and algorithmic stablecoins?

At the moment, the team behind the protocol is  planning on conducting an in-depth analysis of  

the situation, in order to understand the  circumstances which led to such an outcome.

It’s hard to say if the team behind IronFinance  

will decide to fix the shortcomings of  the existing protocol and relaunch it.

Historically, second versions of failed  protocols usually don’t get nearly as  

much traction as their original versions. Yam  Finance was a good example of such a protocol.

After the collapse of IronFinance, there is still  a lot of capital sitting on the sideline looking  

for other high-risk opportunities. It will be  interesting to see where this capital goes next.

So what do you think about the IronFinance  fiasco? Are you optimistic about the future  

of algorithmic stablecoins? Comment down below.

And as always, if you enjoyed this video,  

smash the like button, subscribe to my channel  and check out Finematics grant on Gitcoin.

Thanks for watching!