Polygon (MATIC -13.41%) started the year off with a bang. Through mid-February, Polygon had doubled, from $0.75 to $1.50. But the last six months have been an entirely different story, with Polygon giving up all of its gains and more. Currently trading at about $0.64, Polygon is now down 15% for the year.

Several recent developments have fundamentally changed the way investors view this crypto, and that has resulted in a rethinking of Polygon's upside potential. Let's take a closer look to see if there is cause for concern about Polygon's recent performance.

The Layer 2 investment thesis

Polygon is a Layer-2 scaling solution for Ethereum (ETH -6.10%), the second-largest cryptocurrency in the world. In lay terms, it means that Polygon helps the Ethereum blockchain run faster, cheaper, and more efficiently. And it also means that Polygon's growth is directly tied to Ethereum's growth. For investors, that's actually a very attractive value proposition, and one key reason I've been bullish on Polygon for over a year. There's clear utility in what Polygon offers, and it is arguably still the best-in-class Layer-2 scaling solution on the market.

However, it looks like a wave of new competition is threatening to put Polygon's market-leading position at risk. After all, it's not like Polygon has a monopoly on processing transactions quickly and efficiently. Up-and-coming cryptos such as Optimism (OP -11.29%) and Immutable X (IMX -8.24%) are chipping away at Polygon's best-in-class status. And investors are clearly beginning to notice. Optimism is up 60% for the year, while Immutable X is up 73%. So it's not just that Polygon is lagging the broader crypto market -- it's trailing direct competitors.

Regulatory risk

If that were the end of the story, I wouldn't be as concerned. The underlying technology used by Polygon to process transactions so quickly and so efficiently is considered state of the art, so given enough time, Polygon might be able to figure things out. And Polygon still has a strong relationship with Ethereum.

But the real threat to Polygon might be regulatory risk. Back on June 6, the Securities and Exchange Commission named Polygon as an "unregistered security" in its lawsuits against cryptocurrency exchanges Binance and Coinbase Global. That move was completely unexpected, and investors immediately panicked. In one 24-hour period, Polygon's price fell by nearly 20%. You can see this on a chart for Polygon -- the price literally fell off a cliff on June 6, and hasn't recovered since.

Of even more concern, the SEC scare seems to have triggered alarms within Polygon. Shortly after the SEC suits, Polygon Labs (the blockchain developer firm behind Polygon) started to roll out a new strategic vision for the cryptocurrency, including a brand-new marketing tag line ("The value layer of the internet"). Most likely, there will also be some form of reorganization involved here, including a future rebranding of the MATIC crypto token into the POL crypto token. That creates a whole new layer of uncertainty, however, and could be a sign of deeper problems.

Long-term outlook

On the one hand, Polygon remains one of the top Layer-2 scaling solutions for Ethereum. Vitalik Buterin, the co-founder of Ethereum, has been vocal in his support of these Layer-2 solutions and what they mean for Ethereum's future growth. And Polygon continues to be a top choice for brands looking to launch new blockchain projects, especially new non-fungible token (NFT) projects.

On the other hand, it looks like Polygon may have been a victim of its own success. Other competitors have rushed into the very attractive Layer-2 market, eroding Polygon's market share, and hence its upside potential. 

That said, selling Polygon might make sense if you're a cautious investor. Signals that were once flashing green are now flashing yellow and red. There are plenty of other cryptos trading in the same price range that have similar long-term growth prospects, including some that are direct competitors to Polygon.