Base Layer Controversy Redux: From "Does L2 Count as a Trading Platform?" to the Centralization of Sequencers

Original Article Title: "Base Stirred Up Controversy Again: From L2 Being an Exchange to the Centralization Debate of Sorters"

Original Article Author: Eric, Foresight News

Dubbed the "Crypto Mom," U.S. Securities and Exchange Commission (SEC) Commissioner Hester Peirce stated on The Gwart Show that an L2 relying on centralized sorters may fit the SEC's definition of a trading platform, requiring operators to register with the SEC and comply with regulations.

Hester Peirce indicated that the key to this assessment is not technical but functional; if a single operator controls the matching engine, then it resembles a trading platform. In a sense, this means that as long as there is a centralized organization with transaction control authority over L2, that organization would need to be regulated by the SEC.

Initially, this viewpoint did not spark widespread discussion. However, as it continued to ferment, many began to worry that if even the "crypto-friendly" SEC would reach such a conclusion, the development of L2 might be hindered. Base, which combines elements of a trading platform and L2, became the primary target of criticism.

As FUD grew louder, Coinbase's Chief Legal Officer Paul Grewal was the first to speak out, stating that the SEC defines a trading platform as a market that connects buyers and sellers of securities, whereas L2 operates as blockchain infrastructure providing services to on-chain trading platforms, similar to how AWS provides infrastructure to trading platforms, but AWS cannot be called a trading platform. Paul Grewal believed that incorrectly labeling sorters could lead to overlooking the role of L2 in scalability.

Subsequently, Base's lead, Jesse Pollak, also elaborated on sorters on X, stating that sorters collect user transactions, order them based on a first-in-first-out principle, calculate state transitions, and then aggregate transactions to settle on L1, similar to a traffic controller ensuring smooth flow. Jesse Pollak argued that sorters do not match order transactions; the matching of transactions occurs at the smart contract level, with sorters only ensuring that these transactions proceed in a consistent and orderly manner.

Ethereum co-founder Vitalik Buterin later joined the discourse after Jesse Pollak, asserting that Base is simply an L2 running on top of Ethereum, providing a stronger user experience through centralized features while remaining tightly integrated with Ethereum's decentralized base layer to ensure security. Vitalik emphasized that Base's funds are "non-custodial," meaning that the funds on L2 are ultimately controlled by L1 and cannot be stolen by L2 operators.

Chief Economist Max Resnick of Anza, a development company focused on Solana, raised questions regarding Jesse Pollak's statement. Max Resnick stated that Base's sorter prioritizes transactions based on a 200-millisecond unit as a priority fee, rather than following the first-in-first-out principle. Although Jesse Pollak later provided an explanation, it is evident that Max Resnick's key point is that the sorter can reorganize transactions according to certain rules, directly addressing the centralization issue of the sorter.

The debate on whether L2 solutions like Base constitute a transaction platform does not lead to significant differences in viewpoints. The viewpoint of an SEC commissioner stating that "L2 is a transaction platform" may be due to a lack of understanding of L2 architecture. Discussions within the industry are more driven by regulatory concerns rather than matters of right or wrong. However, the viewpoints of Base stakeholders and Vitalik have sparked another layer of discussion: Should the centralization of Base's sorter be changed?

From Regulatory Issues to the Debate on Sorter Centralization

Vitalik's viewpoint that Base's centralized sorter is for scalability and user experience also stirred significant controversy. Eric Wall, co-founder of Taproot Wizards, stated that concerning fund security, Base is effectively a custodial system. He pointed out that Base's contracts can still be upgraded through governance, indicating that the operator and associated entities (through a security council) retain considerable discretion. In his view, this makes Base functionally closer to a custodial system rather than a fully trust-minimized Ethereum extension. Eric Wall further commented in the thread that Vitalik's wording in expressing his viewpoint may lead readers to believe that even in the event of a key leak, no funds would be lost, which he finds very irresponsible.

Former Ethereum core developer Lane Rettig, on the other hand, stated that while Coinbase itself may not maliciously steal user funds, this does not mean that Coinbase would not engage in user-unfriendly behavior under government pressure.

Alex Thorn, Director of Research at Galaxy, believes that Vitalik's viewpoint did not hit the mark. He stated that the focal point of the discussion should be on securities on L2, rather than the security of L2. Although Alex Thorn did not explicitly state it, his viewpoint hints at a very critical issue: L2 itself is not a transaction platform, but if transaction platforms on L2 are built on a highly centralized chain, can these platforms still be called DEXs, and should they be subject to regulation?

In response to increasing criticism of Base's centralization, Vitalik once again stated that Base is currently in a centralized stage, where the majority of the Security Council can upgrade the contract. However, he pointed out that legal quorum rules prevent Coinbase from unilaterally reviewing or stealing funds. Furthermore, even a 100% Security Council vote cannot change the code running on-chain in the planned second stage.

Anastasia Labs, the developer of Cardano L2 Midgard, sharply commented on Vitalik's remarks with a "reinterpretation": interpreting the "Security Council" as "multisig"; interpreting the "75% vote" as "7 private keys"; and interpreting the requirement that individuals in the council be able to veto proposals with more than 26% voting weight independently of the organization managing L2 as requiring the organization to use shell companies, friends' companies, obfuscated subsidiaries, or partner companies to hold the 3 private keys required for multisig.

Many users in the comment section supported the views of the Anastasia Labs founder. They all believe that although the rules are set up in this way, bypassing them to gain full control over Base is very simple. The opacity of governance makes these transparent rules very unreliable.

The Regulatory Challenge of Web3 Infrastructure

Base's excessive centralization as an L2 has sparked discussions many times. The viewpoint expressed by the SEC commissioner in this case may seem somewhat "absurd," but it also points directly to the core issue: if transaction sequencing on L2 can be manipulated at will, then that L2 should be subject to regulation. Of course, regulating L2 as a trading platform may seem unfounded on the surface, but if the operator of L2 captures MEV revenue by controlling the sequencer, impacting transaction execution prices, etc., then L2 does play a role somewhat similar to a broker-dealer.

For regulatory agencies, determining the "decentralization" of infrastructure is a challenge. Even if the sequencer achieves decentralization, it is difficult to quickly clarify issues such as whether the entities maintaining the sequencer network have conflicting interests. The SEC, concerned about a repeat of the FTX tragedy due to lack of regulation, has relaxed regulations to some extent during the term of the new U.S. president, but it cannot hide its concerns about the significant risks that may arise from regulatory relaxation. Recently, U.S. regulatory agencies have introduced some exemptions for DeFi, but how to define and review infrastructure is still a research question.

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