It is first found on the floor in the first room of the tunnels. The knife is used here as part of a puzzle to open the door, along with an Obsidian knife and Obsidian mace. To open the door, the mace must be placed on the western pedestal and the sword on the eastern pedestal.
It is also one of the weapons found on the floor of the fourth room of the tunnels. It must be used on the northwestern pedestal as part of the puzzle to open the door.
A sword is used once again in the seventh room of the tunnels. It should be placed on a pedastal marked "Xil".