Benefits of Employee Token Incentives
A Brief History of Employee Token Incentives
Stock options are nearly as old as Silicon Valley itself. Over the decades, they have evolved primarily to optimize tax treatment. There have been few innovations that have improved their value proposition to employees. Worse yet, a lopsided balance in understanding how stock options work has resulted in decades of gradual deterioration in fairness of terms to employees.
Employee Stock Option Plans (ESOPs) just aren’t what they used to be.
This lackluster value proposition has resulted in limited adoption outside of US-based startups.
Employee token incentives first gained adoption in the 2017 crypto bull market. Blockchain projects were minting and listing their tokens. There are now over 20,000 coins on CoinMarketCap. With this many Web3 projects and two massive bull runs in 2017 and 2021, employees have voiced their desire to share in the upside.
Founders have been all too ready to oblige. Many early Web3 founders had a libertarian ethos, despising profit hungry centralized models. They were motivated to recruit, motivate, and align their team by giving them a share of the tokens.
DAOs were even created to form the ultimate decentralized, equitable structure, where contributors could invest, vote, and receive tokens. In this article, we stretch our definition of employees to encompass members of a DAO.
Benefits to Employees
From the outset of employee tokens, the appeal of tokens over stock options was obvious. Millennials and Gen Z prefer tokens over options for good reason.
For employees…
- Tokens provide more dilution protection. With employee tokens, founders can commit to a finite max supply of tokens. The difference to their employees is massive. It means employees cannot be diluted for the entire life of the startup. Contrast this with conventional startup equity that is structured to dilute existing stakeholders with each subsequent funding round. A typical series of VC rounds can easily lead to 50% dilution, or more if there is a down round.
- Tokens are more immediate. The immediacy is measurable. IPOs take years, e.g. Airbnb took 12. And that’s if they even get that far. Token launches take 1–3 years, and don’t yet require as mature of a company or product. More evidence will be shared in our next article.
- Tokens are simpler and more tangible. Just like NFTs make JPG ownership more tangible, tokens make equity ownership more tangible. Stock options plans have the right idea, but suffer from psychological pitfalls: (a) humans are not attracted to complexity (e.g. pages of unfamiliar legalese), and (b) humans’ perception of value drops steeply over time if it is not reinforced.
- Tokens are more trackable. Although options can be tracked manually or via SaaS platforms, tokens have a psychological edge because they are always tracked within an employee’s own crypto wallet. Employees can simply visit Etherscan.io and see their tokens without even logging in.
- Tokens can be streamed. If employees see tokens streaming — with a decimal constantly increasing every split second, they see their ownership stake growing. This makes a difference. Humans are attracted to movement. Ticker tapes are addicting. Perhaps, this has primordial roots going back to the survival of cavemen. It’s human nature. Tokens tickle the sweet spot; options miss the mark.
- Tokens can’t be retracted. Employee tokens can vest directly in employees’ own non-custodial wallets. This can’t be taken away — not by the boss, not by the board, not by governments… not by anyone. Options have legal and contractual loopholes.
Many ESOPs are written in favor of the company. They are almost never negotiable, can change upon board approval, and are not even signed by the employee. (Employees usually sign a separate option grant agreement, not the ESOP.) Many ESOPs have a seemingly innocuous requirement for board approval of the final grant. If the board simply does not approve, then the employee has little viable recourse, e.g. hiring a specialized lawyer to sue the company.
A vivid portrayal of this exogenous risk is depicted in the movie The Social Network: Co-founder Eduardo Saverin’s equity stake was diluted by Mark Zuckerberg and the Facebook board. By structuring employee tokens so that they are not exposed to the potential whims of management and the board, tokens will be more readily embraced by employees. - Tokens are more liquid. Once vested and unlocked, tokens are tradable. Options need an IPO (or other liquidity event) before they are tradable. Secondary markets are a complex and rare exception. Employees are generally aware that the chances of an IPO are low for the average startup. So, many discount the value of receiving options. We’ll dig deeper into the economics of this in another article.
- Tokens are given, not bought. Employees must purchase options at a strike price. The price is usually low for early employees, but can be high for later employees. If the stock price drops, employees risk having worthless stock options — or worse, losing money if they already exercised their options. Note this benefit may not last. We expect employee tokens will evolve to require an options exercise. We’ll analyze this in our upcoming article on Restricted Token Units (RTUs).
- Tokens have utility. They are not traditional equity by another name.
Benefits to Founders
For founders…
- Tokens fulfill the promise of the ownership economy. Tokens grant true ownership of projects to “buidlers”.
- Tokens subconsciously align teams. True ownership aligns incentives and even has the potential to smooth out day-to-day internal brouhahas.
- Tokens help with recruiting and churn. Candidates now expect tokens when joining a Web3 project. If they don’t receive it in-wallet, then they are more likely to move on.
- Tokens can be locked. Separate from vesting, tokens can also be programmatically locked from sale for a period of time following the token generation event (TGE), so employees remain incentivized and aligned. This also helps maintain price stability post-launch.
- Tokens can improve the product. By giving tokens to employees, they become more active users, which reinforces the feedback loop.
The advent of token-based equity
The appeal of token-based employee incentives is not restricted to Web3 projects. Web2 startups and even traditional companies can benefit from token-based equity.
The adoption catalyst will be an all-in-one platform that manages all aspects of token-based equity, including the cap table, community airdrops, employee tokens, token generation, and token streaming. Full disclosure: I’m the COO @EthSign and we are building TokenTable, a platform to do just that.
Next up
Upcoming articles in this series will share:
- How stock options have evolved adversely for employees
- A model showing how employee tokens are up to 10x better than stock options
- A free legal template for Employee Token Grants
- Top 10 questions to ask an employer about token vesting
- How to compare cash vs token compensation
- Deep dive into RSUs vs RTUs
- Tax compliance for token incentives
- How to structure tokenomics
- Top 10 Tips: Issuing Employee Tokens
- Deflationary vs Inflationary Tokens: Should max token supply be set?
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This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, financial, or accounting advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction.
