The nickel plating in/on the cylinder is peeling off due to poor manufacturing. This is a common problem with OS engines nickel plating technology. Use the engine while it runs okay, and plan to toss it afterward. The only way to repair it is to replace the piston/liner or have the liner stripped and re-plated. The former will be expensive due to parts availability and the latter even more because the best way to re-plate is with hard chrome and that is expensive due to many parts of the world not allowing it due to environmental concerns with pollution.