Original author: Eric, Foresight News

Hester Peirce, a member of the U.S. Securities and Exchange Commission (SEC) known as “Crypto Mom,” said on “The Gwart Show” that L2, which relies on a centralized sorter, may meet the SEC’s definition of an exchange, so operators must register with the SEC and comply with relevant regulations.

Hester Peirce stated that the key to this judgment is not technology but actual functionality. If a single operator controls the matching engine, it is similar to an exchange. To some extent, this means that any centralized organization with control over L2 transactions will be subject to SEC oversight.

Initially, this viewpoint didn't spark widespread discussion. However, as it gained momentum, many began to worry that if the crypto-friendly SEC reached such a conclusion, the development of Layer 2 (L2) could be hampered. Base, which combines elements of both exchanges and L2, became the primary target of criticism.

As the FUD grew louder, Coinbase Chief Legal Officer Paul Grewal was the first to speak out . He stated that the SEC defines an exchange as a marketplace connecting buyers and sellers of securities, but L2 is a general-purpose blockchain operating as infrastructure that can provide services for exchanges on that chain, just as AWS provides infrastructure for exchanges, but AWS cannot be said to be an exchange. Paul Grewal believes that if the sorter is mislabeled, the role of L2 in scalability may be overlooked.

Later, Jesse Pollak, head of Base, also explained the sequencer at X. He explained that the sequencer collects user transactions, sorts them according to the first-in, first-out principle, calculates the resulting state changes, and ultimately centralizes the transactions on L1 for settlement, much like a traffic controller ensuring smooth traffic. Jesse Pollak argued that the sequencer does not match orders and transactions; transaction matching occurs at the smart contract level. The sequencer simply ensures that these transactions are processed in a consistent and orderly manner.

Ethereum co-founder Vitalik Buterin joined the discussion after Jesse Pollak. Vitalik described Base as simply Layer 2 running on top of Ethereum, offering a more robust user experience by removing centralized functionality while remaining tightly integrated with Ethereum's decentralized foundation for security. Vitalik emphasized that Base's funds are "non-custodial," meaning that funds on Layer 2 are ultimately controlled by Layer 1 and cannot be stolen by Layer 2 operators.

Max Resnick, Chief Economist at Anza, a research and development company focused on Solana, challenged Pollak's assertion, stating that Base's sequencer sorts transactions based on priority fees in 200-millisecond increments, rather than following a first-in-first-out (FIFO) principle. While Pollak later clarified this, it's clear that Resnick's key point is that the sequencer can reorder transactions according to certain rules, directly addressing the issue of sequencer centralization.

The debate over whether L2 platforms like Base are considered exchanges doesn't typically generate much disagreement. The SEC commissioner's assertion that L2 platforms are exchanges likely stems from a lack of understanding of the L2 architecture. Industry discussions are often driven more by regulatory concerns than questions of right and wrong. However, the views of Base stakeholders and Vitalik Buterin have sparked a different discussion: should the centralization of the Base sorter be altered?

From regulatory issues to the debate over sorter centralization

Vitalik's view that Base's centralized sorter is for scalability and user experience has also sparked considerable controversy. Eric Wall, co-founder of Taproot Wizards, stated that in terms of fund security, Base is a custodial system, noting that Base's contracts can still be upgraded through governance, meaning that the operator and its related entities (through the Security Committee) retain considerable discretion. In his view, this makes Base functionally closer to a custodial system than a fully trust-minimized Ethereum extension. Eric Wall also commented in the comments section that Vitalik's wording leads readers to believe that even a key leak would not result in fund loss, which is irresponsible.

Lane Rettig, a former Ethereum core developer, said that although Coinbase itself would not maliciously steal user funds, this does not mean that Coinbase would not take actions that are detrimental to users under government pressure.

Alex Thorn, head of research at Galaxy, believes Vitalik's argument misses the point, stating that the discussion should focus on securities on L2, not L2 security. While Thorn didn't explicitly state this, his point raises a crucial question: L2 itself isn't an exchange, but if L2 trading platforms are built on a highly centralized chain, can they still be called DEXs, and should they be regulated?

In response to growing criticism of Base's centralization, Vitalik reiterated that Base is currently at a centralized stage, where contract upgrades can only be made with a supermajority vote of the Security Committee. However, he noted that quorum blocking rules prevent Coinbase from unilaterally censoring or stealing funds. Furthermore, a second phase is being planned, where even a 100% Security Committee vote will prevent changes to the running on-chain code.

The founder of Anastasia Labs, which is developing Cardano L2 Midgard, sharply published an "interpretation" in response to Vitalik's additional comments: "Security Committee" is understood as "multi-signature"; "75% voting" is understood as "7 private keys"; "requiring individuals on the committee who can veto proposals with more than 26% of the voting rights to be independent of the organization that manages L2" is understood as "requiring the organization to use a shell company, a friend's company, an obfuscated subsidiary or a partner company to hold the 3 private keys required for multi-signature."

There are many users in the comment section who support the views of the founder of Anastasia Labs. They all believe that although the rules are formulated in this way, it is very easy to bypass the rules to achieve complete control over Base. The opacity of governance makes these transparent rules appear very unreliable.

The regulatory challenge of Web 3 infrastructure

Base's over-centralization as an L2 has sparked numerous debates. While the SEC commissioner's views may seem a bit absurd, they also get to the heart of the matter: if the ordering of transactions on L2 can be manipulated at will, then L2 should be regulated. While regulating L2 as an exchange might seem unfounded on the surface, if L2 operators were to manipulate the orderer to pocket MEV profits and influence transaction execution prices, then L2 would, to some extent, be acting like a brokerage.

For regulators, determining the decentralization of infrastructure is a difficult problem. Even if the sorter is decentralized, it's difficult to quickly determine whether there are conflicts of interest between the entities maintaining the sorter network. The SEC, concerned that a lack of oversight could lead to a repeat of the FTX tragedy, has relaxed regulations somewhat under the new US president's term, but it cannot conceal its own concerns about the significant risks posed by such deregulation. US regulators have recently introduced some exemptions for DeFi, but how infrastructure should be defined and reviewed remains a question that requires further study.