As soon as Iofur announces that he's going to fight Iorek, the ceremonial preparations begin. Armorers check Iofur's armor and file his claws to points. Lyra feels sick as she watches Iofur test his claws' sharpness and excuses herself to go cry. When she consults the alethiometer, it again tells her to trust Iorek and reprimands her for asking again. Bears begin to fill the area around the combat ground, and Lyra notices that they all wear badges. Some carry little dolls like Iofur's and Lyra notices that when they see Iofur without his, they seem confused as to what to do with theirs. She realizes that the bears don't know who or what they are, thanks to Iofur.
When the alethiometer reprimands Lyra for asking again, it offers more evidence for the possibility that the alethiometer somehow has its own consciousness. Lyra's observations about how the bears behave shows just how devastating it can be to live in a society that desperately wants its subjects to change who they are—which is, incidentally, what the Magisterium is essentially trying to do with its experiments at Bolvanger.
Lyra looks up at the sky and longs for the witches or Ma Costa to sweep her away to safety and warmth. She cries from fear as the smiths adjust Iofur's armor for the last time. Lyra feels as though she has betrayed her friend: while Iofur's armor covers everything, Iorek's armor leaves much of his body exposed. As they hear a roar from a bear in a watchtower, Lyra excuses herself to go speak to Iorek. She walks across the combat ground and out the other side. In an instant, Iorek is next to her. She desperately explains how she tricked Iofur and tries to justify her behavior, but he praises her, as fighting Iofur is all he wants. He calls Lyra "Lyra Silvertongue." Together, they walk toward the other bears and Lyra briefly touches Iorek as he faces off with Iofur.
The desire to be swept away to safety is another reminder that Lyra is still a child wrapped up in things that are much bigger than she is. Given the bears' size in relation to her, walking through them alone reinforces physically how isolated Lyra is in the world right now. Iorek's praise helps Lyra come to a better understanding of how lies and trickery can be used for good goals. Fighting Iofur and winning will, importantly, mean that the bears once again get to remember who they are and act accordingly—something that will give them far more power and sway.
Iorek roars the terms of the fight: if Iofur wins, he'll be the king of the bears forever. If Iorek wins, he'll tear down the palace. Iofur roars and gives his own terms, insisting that he summoned Iorek for this fight. Lyra watches and realizes that though Iorek's armor isn't as splendid, it fits him and truly is his soul. Iofur, meanwhile, isn't content with his armor. She sees the other bears making the same comparison and realizes that this is a crossroads for the entire bear culture. Finally, the bears attack each other. Iorek destroys parts of Iofur's armor, though Iofur's attack makes Iorek bleed profusely. The bears continue to box and slash at each other. Iofur's armor is in poor shape, but Iorek begins to favor his left front paw.
Understanding the significance of this fight for the panserbjørne culture shows that Lyra is truly beginning to come of age and understand all the variety and cultural differences in the world. Further, seeing that Iorek's armor is undeniably his soul shows her clearly that one doesn't need a dæmon to be whole and have a soul; Iorek is who he is because he's comfortable with his soul and what it can do for him. Similarly, Iofur's armor appears weak, which suggests that Iofur is similarly weak.
Iofur taunts Iorek and backs him up across the ground. Lyra cries and knows that Iorek is going to die. In truth, Iorek is tricking Iofur—Iofur doesn't want to be a bear, so he's susceptible to tricks like a human. Finally, as Iofur rears up, Iorek leaps and tears Iofur's lower jaw off. Iorek grabs Iofur's throat and the massive bear dies. Iorek performs the final ritual: cutting out Iofur's heart and eating it. The bears roar their approval, tear off their badges, and begin to dismantle the palace. Lyra shouts that there are human prisoners in the palace, so Iorek commands that the prisoners be brought out first. Lyra helps Iorek tend to his wounds and then curls up to sleep.
Iorek's victory—though brutal in its execution—more broadly champions the idea that beings should be comfortable with who they are, no matter who that may be—and that sense of self-knowledge is what allows people to be successful in the wider world. This offers a hopeful note in terms of the Magisterium, as it suggests that the organization will ultimately be unsuccessful in trying to fundamentally change humans and who they are.
A bear wakes Lyra up and tells her to come to Iorek. When they get to an assembly of bears, she sees that Roger is there too. He says that he and Iorek fell out of the balloon and he has no idea where Lee Scoresby or the witches are. The young bear shows Lyra and Roger how to eat warm, raw seal blubber and kidneys and then leads them to Iorek and his counselors. The bears allow the children to join the circle and tell Lyra how Iofur ruled them like they were under a spell. Mrs. Coulter had given Iofur a drug, which he used to orchestrate Iorek's wrongful killing of another bear.
That Mrs. Coulter was able to introduce human tools (like this drug) into the bears and use them to control Iofur shows again how powerful human systems are in Lyra's world, even against creatures as strong and normally self-assured as the panserbjørne. Depriving them of that self-assurance is exactly what allowed Mrs. Coulter to control Iofur.
A counselor, Søren Eisarson, says that since human laws don't apply on Svalbard, Iofur was going to let Mrs. Coulter set up a place worse than Bolvanger and do things that would be illegal elsewhere. Lyra consults the alethiometer and discovers that Lee Scoresby is airborne somewhere far away. She ascertains that Mrs. Coulter is on her way to Svalbard with machine guns and Tartars. Mrs. Coulter had planned to overpower Iofur, but will learn that Iorek is king from her spies. Lyra then says that Mrs. Coulter is going to kill Lord Asriel because she's afraid of what he's doing and wants to do it herself. Mrs. Coulter is also after Lyra and something that Lyra has, but that Lord Asriel also wants. Lyra thinks that they both want the alethiometer, but she can't quite figure it out. Iorek offers to take Lyra to Lord Asriel.
It's important to note that Lyra can't quite figure out what the alethiometer is trying to tell her; given how similar situations have historically gone for her, this suggests that there's tragedy ahead. It's also worth noting that Mrs. Coulter is, at this point, driven by fear of something. This suggests that she's going to be even more unreasonable than usual, given how fear tends to make the novel's characters even less likely to behave normally and rationally.