In 2022, Polygon (MATIC -1.37%) was one of the hidden gems of the crypto market, primarily because its prospects were so tightly aligned with those of Ethereum (ETH 0.70%). Polygon is a scaling solution for the Ethereum blockchain, so it made perfect sense that any future growth in Ethereum as a result of The Merge system upgrade would also result in future growth for Polygon.

But it's been a different story entirely for Polygon in 2023, with the crypto token up less than 1% year to date. It might still be a top crypto by market capitalization, but there are plenty of reasons to be concerned right now. If you are thinking about buying Polygon, here's what you need to know.

The regulatory overhang

The biggest issue facing Polygon right now is a potential regulatory enforcement action by the Securities and Exchange Commission (SEC). On June 6, the agency named Polygon as one of a handful of cryptos that the agency deemed "unregistered securities" being offered for sale on cryptocurrency exchanges Binance (BNB -0.31%) and Coinbase Global (COIN 7.37%). As might be imagined, the price of Polygon immediately fell by more than 20% as investors panicked.

Worried-looking person watching a smartphone.

Image source: Getty Images.

The good news is that momentum for regulatory action against Polygon has diminished this month, thanks to a positive court ruling for crypto token XRP (XRP -0.39%), which the SEC has been trying to classify as a security for nearly two years.

So, if you're a glass-half-full type of investor, the regulatory situation around Polygon might not be quite as dire as it seemed to be a month ago. Over the past 30 days, Polygon is actually up more than 20%. 

Too much competition

Polygon is also facing a tremendous rise in competition within its market niche. As a Layer-2 scaling solution for Ethereum, it helps to make Ethereum run faster, cheaper, and better. You can think of it as a secondary blockchain that sits on top of the main Ethereum blockchain to process transactions faster. 

The problem is that there are a lot of other crypto tokens offering the same services for Ethereum, including Optimism (OP -2.43%). All of these scaling solutions use a form of proprietary technology that helps them process transactions faster than the main Ethereum blockchain.

At one time, Polygon was the obvious leader in this niche, but investors clearly no longer think this is the case. While the price of Polygon has barely moved this year, Optimism is up 66%.

An uncertain rebranding

At the beginning of the year, there were layoffs at Polygon Labs, the company behind the launch of the Polygon blockchain. This 20% workforce reduction was followed by the SEC regulatory drama in June. And all of that has led to the inevitable: a pivot in business strategy and a crypto token rebranding.

Just a week after the SEC news broke, Polygon started talking up its intentions to become "the value layer of the Internet" as part of its coming transformation from Polygon into Polygon 2.0. Given the timing of this new strategy, there is uncertainty about what this transformation will entail or how it will work.

Polygon says it is going to rebrand its token, now known as MATIC, to POL. This will be done to recognize the fact that the new-and-improved Polygon will be a "hyperproductive token" for multiple blockchains. 

It's hard to make sense of all this, but it seems to suggest that Polygon wants to become a scaling solution across more blockchains than just Ethereum. That could be good news if it leads to new growth opportunities. Or it could make things way more confusing.

What does it all mean?

There obviously are a number of issues swirling around Polygon right now, and it could be time to sell if you're particularly risk-averse. There has been an explosion of competitive pressure, followed by a potential SEC regulatory fight.

Add in a crypto token rebranding that seems to have come out of left field, and there are reasons to be nervous. At this time, I can't offer a bullish long-term outlook for Polygon.