Batteries with conversion-type electrodes exhibit higher energy storage density but suffer much severer capacity fading than those with the intercalation-type electrodes. The capacity fading has been considered as the result of contact failure between the active material and the current collector, or the breakdown of solid electrolyte interphase layer. Here, using a combination of synchrotron X-ray absorption spectroscopy and in situ transmission electron microscopy, we investigate the capacity fading issue of conversion-type materials by studying phase evolution of iron oxide composited structure during later-stage cycles, which is found completely different from its initial lithiation. The accumulative internal passivation phase and the surface layer over cycling enforce a rate-limiting diffusion barrier for the electron transport, which is responsible for the capacity degradation and poor rate capability. This work directly links the performance with the microscopic phase evolution in cycled electrode materials and provides insights into designing conversion-type electrode materials for applications.