Developer Ignites Firestorm, Claims Ethereum Layer-2s Operate As Unregistered MSBs

Ethereum
is
a
legacy
chain
that
has
scaled
over
time
to
address
the
needs
of
the
ever-demanding
global
user
base.
To
relieve
the
mainnet
of
the
deluge
of
transactions,
more
layer-2
platforms
have
sprouted.

They
are
cheaper
to
transact
on
and
scalable,
allowing
users
to
deploy
intensive
decentralized
applications
that
won’t
be
feasible
on
the
base
layer.

Ethereum
Layer-2s
Are
A
Success,
But
There
Is
A
Problem

According
to
L2Beat,
layer-2
platforms
on
Ethereum
currently manage over
$39
billion
in
total
value
locked
(TVL).
Even
so,
Nikita
Zhavoronkov,
a
lead
developer
at
Blockchair,
is
concerned
and
thinks
layer-2s
are
a
“huge
legal
liability
waiting
to
happen.”

Taking
to
X,
Zhavoronkov argues that
layer-2
protocols
on
Ethereum
and
Bitcoin
are
vulnerable
to
regulator
crackdown. In
the
developer’s
assessment,
these
platforms
resemble
money
service
businesses
(MSBs),
considering
how
they
are
designed
to
operate.
Since
they
are
not
regulated,
the
developer
said
they
might
be
operating
illegally.

Top
of
the
list,
Zhavoronkov
argues
that
most
existing
layer-2
solutions
are
not
truly
decentralized.
They
point
to
using
multi-signature
contracts
or
“emergency
councils”
controlled
by
limited
groups
as
evidence
of
centralized
control. 

Moreover,
the
developer
highlighted
the
custodial
nature
of
many
layer-2s.
Users
do
not
directly
control
user
funds
based
on
how
these
scalable
platforms
operate.
The
analyst
says
this
tinge
of
centralization
presents
a
vulnerability
if
regulators
target
these
entities.

Zhavoronkov
adds
that
though
layer-2
platforms
are
enablers,
working
from
a
trustless
base,
they
function
as
for-profit
businesses,
generating
revenue
from
transaction
fees.
Because
some
of
them,
like
Optimism
and

Arbitrum,
issue
tokens,
revenue
accrued
can
impact
token
prices.

The
developer
contends
that
this
is
why
layer-2
platforms
are
no
different
from
traditional
companies
than
truly
decentralized
platforms.

More
Headwinds
For
ETH,
United
States
SEC
Reported
Investigation

Given
their
mode
of
operation
and
model,
Zhavoronkov’s
assertion
that
layer-2
solutions
could
be
classified
as
MSBs
under
United
States
laws
is
a
concern.
Such
a
classification
could
subject
these
protocols
to
stringent
regulations,
compliance
requirements,
and
potential
sanctions. 

This

not
only
threatens
to
stifle
innovation
but
also
has
the
potential
to
hamper
Ethereum’s
scalability
severely.

While
some
have
dismissed
Zhavoronkov’s
viewpoint
as
“distorted,”
the
fact
that
Ethereum
is
reportedly
under
investigation
by
the
United
States
Securities
and
Exchange
Commission
(SEC)
adds
a
layer
of
complexity
to
the
situation. 

Analysts
say
the
SEC’s
classification
of
ETH
as
a
security
rather
than
a
commodity
like
BTC
could
further
delay
the
approval
of
spot
Ethereum
exchange-traded
funds
(ETFs).

Feature
image
from
Canva,
chart
from
TradingView