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Ethereum Bitcoin layer-2s

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

Dalmas Ngetich
by Dalmas Ngetich
1 year ago
·
Posted in Ethereum
Trusted Editorial content, reviewed by leading industry experts and seasoned editors. Ad Disclosure

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.”

Ethereum layer-2s TVL | Source: L2Beat
Ethereum layer-2s TVL | Source: L2Beat

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.

Related Reading: Pro-XRP Lawyer Outlines Reason Behind Senate Seat Campaign – Here’s What It Is

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.

Ethereum price trending upward on the daily chart | Source: ETHUSDT on Binance, TradingView
Ethereum price trending upward on the daily chart | Source: ETHUSDT on Binance, TradingView

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. 

Related Reading: Crypto Influencers Exposed: Following Their Advice Could Cost You Big — Research

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
Editorial Process for bitcoinist is centered on delivering thoroughly researched, accurate, and unbiased content. We uphold strict sourcing standards, and each page undergoes diligent review by our team of top technology experts and seasoned editors. This process ensures the integrity, relevance, and value of our content for our readers.
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Dalmas Ngetich

Dalmas Ngetich

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Dalmas is an experienced journalist with over a decade in Forex, general finance, technology, and blockchain developments. He is currently a crypto reporter for Bitcoinist, where he covers DeFi, blockchain, DeFi, and latest industry news. His work and that of his partners have been featured in top news outlets, including Forbes, investing.com, CoinTelegraph, and Entrepreneur, among others. He is passionate about technology and politics and is always on the lookout for the latest trends in these fields. He also loves spending time with his family and friends, exploring nature, and traveling to new places. Connect on X: @Dalmas_Ngetich, or message him directly on Telegram here: @Dalmas_Ngetich.

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