Tokens are not equity, tokens are one of the most powerful tools for Web3 companies. Tokens can incentivize good behavior, coordinate stakeholders, and build decentralized communities. Over the past decade, tokens have also emerged as a way to attract, compensate and reward talent.
Since most projects develop open source software that generates value independent of the company leading the project and its ownership stake, it's important to ensure that employees are compensated for their contributions. Many teams include tokens as part of their compensation. At the same time, Web3 company leaders, talent teams and HR departments are developing increasingly sophisticated ways to use tokens to shape compensation packages so that they can compete with other companies and even attract talent from the broader Web2 industry .
Incorporating tokens into payroll systems presents unique complexities, challenges, and opportunities. For example, compensation can be structured in many ways, and what works for one company may not work for another. So, in this article, we’ll explore how tokens fit into a broader compensation strategy, and then analyze the specific details of token rewards, including vesting schedules, lock-up periods, and taxes.
First, tokens are not equity
While many token compensation strategies are rooted in Web2 traditional company compensation models, let’s be clear: tokens are not equity. They're not even a proxy for equity, so companies should be careful with such analogies in both internal conversations and when explaining them to potential employees.
From an employee perspective, receiving tokens and receiving equity are two different experiences with different risks and rewards. The protocol is autonomous software, not a company. Unlike equity, the board or management team does not work to maximize the value of the tokens.
There are many factors to consider when allocating tokens, and employees are just one part of them. (For more information on token distribution, click here .) For example, there are many laws and regulations specific to tokens and Web3 that startups will need to consider carefully when determining the strategic role of their tokens.
Now, let’s dive into some important principles of token compensation…
A beginner’s guide to building a token compensation strategy
Token compensation is part of a compensation strategy with the ultimate goal of rewarding work and retaining employees without compromising employee engagement. This involves how to shift employees’ attention from token prices to building the future.
This is uncharted territory, especially for talented teams managing token compensation for the first time. The good news is that while we've highlighted the differences between Web2 and Web3 compensation, HR teams can still learn a lot from successful Web2 models. In fact, they will need to do this if they are to compete with traditional companies for talent, especially in hot areas such as artificial intelligence.
Let’s start with the basics: It’s critical to establish a compensation philosophy that is clear, transparent, and easy to understand. It’s been proven that pay transparency and fairness have a significant impact on employee engagement, and companies can’t afford to make a mistake here.
Once established, this compensation philosophy will guide decisions about hiring, salary levels and salary ranges, long-term incentives (tokens, equity or both), promotions, raises and advancement, and more.
A good compensation philosophy usually also answers the following questions:
- What is the base salary for a job?
- How much of an employee’s total compensation comes from tokens and equity?
- What is the company's base salary to total compensation ratio?
- What is the company's total compensation target for each position?
- How does the company define market compensation? For example, who are the peer companies? Who are you most likely to compete with for talent?
Once these questions are answered, companies can start digging into specific questions: How often should employees receive tokens? What’s the difference between cash and tokens? etc.
Balancing cash compensation and token compensation
In a traditional compensation package, base salary is an important way to balance the risk associated with equity. The same is true for token compensation, which is only part of the employee's "total compensation."
For Web3 companies, total compensation includes:
- Base salary and performance bonuses make up total cash compensation, usually paid in fiat currency
- Equity, including non-qualified stock options (NSO), incentive stock options (ISO), employee stock purchase plan (ESPP), etc.
- Token remuneration, paid using project tokens or other tokens (Bitcoin or Ethereum, etc.) and stablecoins
A simple rule of thumb is to offer a healthy cash compensation that is competitive with peer companies. What is the percentage of total compensation in cash and tokens? What we usually see is:
- Total cash: 75% of market salary
- Total compensation (total cash plus bonus, plus equity value): 75%-90% of market compensation. Total cash includes base salary and other cash components such as performance bonuses
- Premiums: Some teams may also offer “premiums” for access to special talent, such as protocol or smart contract engineers, or talent specializing in cryptographic security. These premiums are reflected in higher base salaries and total compensation.
We often hear the question: “Should we give employees the freedom to choose the ratio of tokens to cash in their compensation?” While there’s no hard and fast rule, it’s usually best to limit the token portion to a specific percentage of total compensation. Rather than letting employees choose a percentage.
Not only do finance teams have to keep track of various bespoke arrangements, but drastic changes in token prices can disrupt a company’s overall compensation strategy. For example, a sudden price drop may force employees to renegotiate their pay packages. At the same time, soaring prices could make some workers suddenly rich beyond their paychecks to others.
Token vesting plan
Having a fixed percentage of tokens doesn't mean your token balance won't change.
The tokens themselves can function in a number of different ways, depending on when and how they are distributed. Companies have many options in this regard: short-term incentive plans, long-term incentive plans, and classic mechanisms such as vesting plans and bonuses.
The most effective model will depend on the company's specific circumstances and philosophy: Is the token a public offering? What types of tokens does the team offer? Are there any restrictions on how tokens can be traded?
Here we list some common token vesting schedules and their pros and cons to help founders unfamiliar with best practices. Note that these schedules work best for projects with publicly traded tokens that have set aside a certain number of tokens for ongoing employee incentives.
Founders need to balance depleting token reserves and building employee rewards with incentivizing third-party contributions to drive decentralization.
One-year lock-in period, four-year vesting period
In this model, employees receive their first batch of tokens when they join the company. After the first year, the tokens in the first quarter will vest, and the remaining tokens will vest on a quarterly basis (or month or year).
- Advantages: Rewards employees for their contributions to projects.
- Disadvantages: Employees hired during different months of the same year can have drastically different results, especially during times of market volatility. Longer time frames can also put employees on an emotional roller coaster.
annual awards
Given that token prices vary so much over time, some teams find it doesn’t make sense to distribute tokens over a multi-year period. Therefore, there is a tendency to award awards on an annual basis. Each employee will receive tokens distributed at market prices annually. Then, after the first assignment, the talent team typically adds performance metrics to the calculation.
- Pros: This approach reduces employee tolerance for token volatility risk, making compensation more predictable and thus reducing distractions.
- Disadvantages: Compared with the four-year incentive plan, the token appreciation potential is reduced and may lose its appeal to talents.
Four-year incremental vesting
This model is designed to keep employees motivated, increasing the incentive amount as the employee's time on the job goes on, starting with a smaller percentage (such as 10%) and reaching 100% after four years. This model also typically involves a 1-year lock-up, with few companies vesting tokens in the first year.
Pros: Incremental rewards encourage employees to stay longer.
Disadvantages: This model can make recruiting more difficult due to smaller employee benefits in the short term. Only a few Web3 companies currently adopt this structure, but as the industry grows, more may adopt it.
As with any vesting plan, reducing the impact of token price volatility needs to be considered, so consider using methods like the 90-day moving average when pricing and allocating tokens. Companies should also ask their advisors to carefully study any vesting plan changes they see in response to market fluctuations.
Finally, keep in mind that many coins, especially those that are about to launch, require planning for a lock-up period. A token lock-up period (i.e. one that is restricted from circulation for a period of time after launch) not only helps ensure the long-term success of the project, but is also important for aligning the interests of all stakeholders; for more information on the lock-up period, please click Select here .
lock-in period
Founders should ensure that "insiders" (employees, investors, consultants, partners, etc.) have the same lock-in period and rules. If some of these groups are able to sell before others, this could create distrust, violate securities laws, and have other negative consequences for the agreement.
For U.S. employees, companies should plan for a lock-in period of at least one year (for legal reasons explained here). Three to four years may be more conducive to the long-term success of the project, as a longer period can reduce downward pressure on prices and demonstrate confidence in the long-term viability of the project.
For candidates coming from Web2, some education may be required as long vesting timelines and lock-in periods can feel burdensome. Assuming the lock-in applies to all pre-release token holders, candidates should expect to see a lock-up period built into their salary structure, as this shows that the founders prioritize the stability of the protocol and believe it has real utility.
Finally, from a practical perspective, the lock-up period can be managed through smart contracts and managed by a token management service provider. Once the tokens vest and the lock-up period ends, employees can transfer the tokens to their wallets. Encoding token distribution into smart contracts helps build trust with employees.
Token Reward Framework: RTA, TPA and RTU
Currently, there are three main ways for Web3 companies in the United States to build token rewards. They are all modeled after equity awards, which provide the most common asset-based compensation template, but again, to be clear, tokens are not equity:
- Restricted Token Awards (RTA): Similar to equity options that employees might receive before a traditional company goes public.
- Token Purchase Agreement (TPA): Another way to structure pre-release token grants with different tax implications (see below).
- Restricted Token Unit (RTU): Similar to Restricted Stock Unit (RSU). RTU is used when a coin has been launched and trading begins.
RTA and TPA are two ways for companies to provide token compensation to employees who are hired after the token is minted but before it is launched to the public. They are often compared to stock options offered by traditional pre-IPO companies.
Both RTA and TPA are available according to the vesting schedule we outlined earlier, and both typically come with:
- A lock-up period, during which they cannot be sold or transferred to another wallet;
- Forfeiture rights, allowing companies to reclaim tokens before they vest
The main difference between an RTA and a TPA is tax, so founders should consult an attorney when evaluating the appropriate type of award. For example, tax timing is a key consideration and depends on the type of token rewards issued.
RTA
The RTA allows U.S. recipients to file Form 83(b) with the IRS to recognize income upon receipt of tokens based on fair market value on the date of grant. This could be beneficial to employees, especially if the value of the token is expected to increase. Additionally, filing an 83(b) prevents the potential risk that an employee may owe taxes on tokens that have vested but cannot be sold. Please note that an 83(b) must be filed with the IRS within 30 days of the date the tokens are awarded.
TPAs are similar to RTAs in that they can be granted to employees before the token is publicly released and also allow employees to file a Form 83(b). But unlike RTAs, they require employees to purchase tokens at a specific price (also called the "strike price"). It's not surprising that employees tend to choose RTAs, but TPAs have some tax benefits. Unlike RTAs and RTUs which are taxed as ordinary income, the grant of a TPA does not create a tax liability. Taxation is deferred until the employee exercises his option or sells his token; and upon exercise, only the increase in the token's value relative to the exercise price is recognized as income.
RTU
RTUs, on the other hand, are usually issued to employees who join after the token is issued, and the concept is similar to the RSUs offered by many large companies.
RTUs are awarded at the beginning of employment and are subject to one of the vesting schedules listed above. Once vested, employees can typically transfer tokens to a wallet of their choice, unless there is a lock-up period. Tokens are taxed as income at their current fair market value when they vest, so some companies choose to withhold a portion of each employee's bonus to pay their tax liability.
While this discussion focuses on token recipients, companies should also consider their tax withholding obligations if they are required to pay in cash.
Please note that none of the above should be considered tax advice. But we hope it provides an overview of the various strategies currently being used by Web3 companies. We strongly recommend that Web3 talent, legal and tax teams work together to determine the best course of action for their company and strategy. If liquidity is the primary driver for a token, there are other strategies, such as conducting a secondary offering so employees can access liquidity as the company raises more funds.
How-to guide: How to manage token compensation
This sounds complicated, but the good news is that more and more companies are developing products and tools to make token rewards operationally easier to manage. Typically, startups will have a wallet (from a company like Coinbase, Anchorage or BitGo) and a token management system (from a company like Toku or Pulley) that handle all the management.
Employees will then receive the tokens by accessing the wallet through the token management system. They should also be able to use the system to review the progress of their assets.
Summarize
Web3 companies are still growing. By using well-tested and refined compensation strategies, they can meet the challenge of attracting top talent.
The basic principle is to ensure that tokens are part of a well-designed compensation strategy. This strategy is transparent, fair and motivating, and will not only attract and retain some of the best talent in the short term, but also ensure employees are appropriately rewarded for their contribution.
While companies can pursue other strategies, such as offering secondary token offerings to employees as they raise additional capital, token compensation remains an attractive way for Web3 companies to level the playing field.
