The EU Markets in Crypto-Assets Regulation (MiCA) is a sweeping piece of legislation set to redefine the regulatory landscape for crypto-assets in the EU. As MiCA's full implementation date of 30 December 2024 approaches, firms are working to comply with MiCA's extensive requirements, with others only now discovering that MiCA may apply to their operations. An area that has potentially been overlooked is the regulatory treatment of token bridges under MiCA. Depending on their structure, token bridges—and their operators—could fall within MiCA's regulatory scope, having far-reaching implications for the crypto-asset industry.
A major challenge for blockchains is that they generally lack interoperability—blockchains are typically isolated networks with no built-in way to interact with each other. This creates a friction point for users who want to transfer tokens between blockchains.
Token bridges fill this gap by providing a method for tokens to be 'transferred' between two blockchains. Although their technical implementations can vary, token bridges generally work by having users deposit their tokens in a smart contract or wallet on the 'source' blockchain, and in return the token bridge issues a corresponding amount of 'wrapped' tokens to the user on the 'destination' blockchain. When users want to 'unwrap' their tokens, they simply reverse the process, redeeming their wrapped tokens on the destination blockchain for the original tokens on the source chain. The token bridge operator—typically acting to some extent through an automated protocol—oversees the issuance and redemption mechanism and safeguards the deposited tokens on the source blockchain.
While wrapped tokens may look and function similarly to the original tokens from the user's perspective, they are technically distinct tokens. This distinction is crucial from a regulatory perspective, as wrapped tokens might trigger certain regulatory obligations under MiCA.
The regulatory classification of token bridges under MiCA could have far-reaching implications for industry participants. Token bridges provide a useful tool for allowing users to effectively 'move' tokens between blockchains. Subjecting bridges and operators to MiCA's regulatory requirements could increase compliance costs and ultimately be troublesome to crypto markets.
There are two main issues concerning token bridges under MiCA: (i) the potential qualification of wrapped tokens as asset-referenced tokens, and (ii) the potential qualification of the token bridge operator as crypto-asset service provider. Both points are discussed below.
Under MiCA, asset-referenced tokens are a type of crypto-asset that purport to maintain a stable value by referencing another value or right or combination thereof, including one or more official currencies. Asset-referenced tokens are distinguished from e-money tokens, which purport to maintain a stable value by referencing a single official currency (e.g., US dollar or euro).
Depending on the technical implementation of the token bridge, wrapped tokens could qualify as asset-referenced tokens under MiCA. Wrapped tokens are designed to maintain a stable value in relation to the original token. Without this reference, the wrapped token would have no value; its value is inherently tied to the ability of users to exchange the original token and the wrapped token via the token bridge, usually at a 1:1 ratio. On these facts alone, wrapped tokens could fall within the scope of MiCA's broad definition of asset-referenced tokens.
Issuers of asset-referenced tokens are subject to extensive regulatory obligations under MiCA, including the requirement to obtain a license before issuing the token within the EU. Additional obligations include minimum capital requirements, maintaining a reserve of assets and publishing a crypto-asset white paper, among other obligations. Whether MiCA's requirements apply to a specific wrapped token depends on the particular facts and circumstances. MiCA includes certain exemptions from the license requirement (e.g., issuances totaling less than EUR 5 million over a 12-month period). Furthermore, MiCA's requirements might not apply if the wrapped token has no identifiable issuer.
Under MiCA, a license is required to provide crypto-asset services within the EU. With regard to token bridges, operators might trigger the license requirement for providing custody services or transfer services.
Custodial services under MiCA entail 'the safekeeping or controlling, on behalf of clients, of crypto-assets or of the means of access to such crypto-assets, where applicable in the form of private cryptographic keys'. Where token bridge operators hold the private keys to the deposit wallet or maintain control over the smart contract where the original tokens are held, there is a good chance that this would qualify as a custodial service under MiCA.
Transfer services under MiCA involve 'providing services of transfer, on behalf of a natural or legal person, of crypto-assets from one distributed ledger address or account to another'. Whether this service applies depends on the technical implementation of the token bridge, but if users can request that their original tokens be transferred to a different address from the one initially used with the bridge, the operator may meet the criteria for providing a transfer service.
In addition to the obligation to obtain a license, crypto-asset service providers must adhere to various prudential and regulatory requirements under MiCA. For example, custodial service providers are required to establish a custody policy and to provide their clients with a statement of positions at least once every three months. Providers of transfer services must conclude agreements with their clients that incorporate specific provisions as outlined in MiCA.
Moreover, crypto-asset service providers are required to perform know-your-customer (KYC) checks and anti-money laundering (AML) due diligence on their customers. These obligations may call into question the practical feasibility of operating a token bridge altogether.
With careful planning, it may be possible to structure a token bridge in a way that excludes wrapped tokens and bridge operators from MiCA's scope.
As previously mentioned, asset-referenced tokens are generally not subject to MiCA's requirements if they have no identifiable issuer. Although MiCA does not provide a definition of 'no identifiable issuer', it implies that there is no person or entity that exercises sufficient control or influence over the issuance of the token. Therefore, if a token bridge can autonomously issue and redeem wrapped tokens without relying on any identifiable person or group, an argument could be made that the wrapped tokens fall outside the scope of MiCA.
Furthermore, MiCA exempts crypto-asset services that are provided in a 'fully decentralized' manner. This exemption generally follows the same criteria used to assess the presence of an identifiable issuer: if no person or group can be identified as an intermediary, the service might fall outside MiCA's scope. For token bridges specifically, the challenge lies in managing custody of the original tokens. A potential solution could be to use a mint-and-burn mechanism on the source and destination blockchains, where tokens on the source chain are burned as the corresponding wrapped tokens are minted on the destination chain (and vice versa), thereby eliminating the need for any party to maintain custody of the original tokens. However, whether this approach is feasible might depend on the technical requirements of the respective blockchains involved.
Token bridges represent a critical yet nuanced area of regulatory interest under MiCA. Whether wrapped tokens qualify as asset-referenced tokens or whether bridge operators qualify as crypto-asset service providers, MiCA's application will have substantial implications for cross-chain technology and interoperability. Firms engaged in token bridge activities should seek thorough regulatory analysis to avoid potential compliance pitfalls, as MiCA’s licensing and operational requirements could dramatically impact their business models and future operations in the EU.
