Employee Incentives in a Tokenized World
How incentive pay will evolve in the blockchain industry
Tokens created by teams building blockchain protocols and applications will significantly change incentives for employees in ways that can’t be done with stock options. As token models grow, founders and teams need to think critically about the benefits and consequences of token incentives in order to best harness their potential.
Downsides to stock options
Stock options are a widely-used form of incentives in the startup world today. They give employees the hope of participating in meaningful company upside, often in return for taking a lower salary. If you are unfamiliar with how stock options work, you can read my quick explainer here.
While options are widely used (and for good reason), they do have limitations:
- Employees must be granted options by the company board?—?there’s no other way to get them.
- Options are only worth something if you have a way to sell the shares they represent.
- Employees who join the company at later stages usually get fewer options that cost more per share.
The use of tokens as incentives could solve many of the problems with options, and I think it’s worth exploring how this could play out.
Note?—?this post makes the following assumptions:
- Tokens remain valuable once we’re past the current crypto bubble. This means people actually start using the tokens to buy stuff (?).
- I’m mostly talking about startups, not well-established and/or publicly traded companies.
- If you’re fuzzy on what is different about token value vs stock value, please read my thoughts on it before continuing.
Tokens provide early-stage liquidity
Stock options require a liquidity event to sell the underlying shares. This can take 5–10+ years after a company is started. Tokens, on the other hand, can be sold at any time once trading is active (assuming the tokens aren’t restricted due to vesting), which could mean employees gain liquidity for their tokens immediately after creation.
This faster liquidity will draw more talent to the blockchain industry, which is on the whole a good thing. When it comes down to it, people are highly motivated by money, and they’ll flock to work in an industry that provides opportunities to make good money. While token liquidity is clearly valuable for individuals, token structures should still be managed to ensure alignment with long-term company success.
Short-term vs long-term goals
Since options take a long time to return profits to holders, employees are incentivized to increase the long-term value of the company. They are theoretically more likely to build a solid foundation, allowing the company to scale over many years. The more valuable the company is at the liquidity event down the road, the more money the option holders make.
How will the faster liquidity provided by tokens affect employee desire to work toward long-term goals? The liquidity and publicly-traded nature of tokens could disincentivize long-term value creation; just look at current publicly traded corporations. It’s generally accepted that quarterly earnings releases and publicly-traded stock cause executives to optimize for short-term profit over long-term success (known as “short-termism”; analyses here and here). In a small and fragile startup, short-termism can be a deathblow.
Imagine the scenario where teams spend more time marketing how awesome their product will be than actually building it (you don’t even have to imagine that, there are too many real-world examples to choose from). In the short term, this increases token value and allows employees to cash out. But in the long term, there’s either no product or the product sucks, and the public token owners are left holding the bag. That’s a recipe for SEC action if I’ve ever heard one, and it’s definitely not the way to build a sustainable company.
Serious founders of new token-based companies should beware of the short-sighted trap when designing employee token incentives. Create long-term token vesting schedules, hire people who are genuinely interested in helping the platform grow, and be an evangelist for your token: prove to employees that future token value will grow the most by building a sustainable product.
Intra-company trading economies
Moving past finite option pools
Companies typically have a finite pool of options to use for incentivizing employees. After this pool is exhausted, new employees are no longer granted options?—?there is no way for them to meaningfully participate in the company’s success or failure. Lack of ownership in company success demotivates the team.
With tokens, even if there’s a finite pool, employees can still gain exposure to token gains by purchasing them on the secondary market. (Public exchange purchases are pretty straightforward, so I won’t go into it further here.)
But what about later-stage employees purchasing tokens from other employees? This is the part that blew my mind as I was thinking through it. A full internal economy for token exchanging could naturally grow inside the company?—?something that is not possible with stock options. Early employees can get liquidity faster by selling tokens to later employees, and later employees can buy exposure to company success, even though that exposure isn’t directly granted by the company itself. The employees don’t have to rely on the company allowing them to participate in meaningful upside; participation becomes an individual choice?—?a hallmark of decentralization.
Why would early employees sell their tokens to later ones instead of selling on the open market?
- It may be more convenient and secure than selling on an exchange. You don’t have to pay exchange fees or give up control of your tokens to a third party wallet.
- There may be a trading lockup keeping them from selling on public exchanges. Companies could waive this lockup for intra-company trading because…
- It builds team camaraderie. The more teammates who have exposure to company performance, the better a sense of cohesiveness is created. The team feels “in it together,” creating a virtuous cycle of motivation.
Loss-aversion as motivation
Buying tokens from other employees or on the open market is a direct bet on the company’s performance?—?success or failure. That’s different from options, which you don’t have to purchase. If the company fails, you never purchase the shares, so you don’t lose money?—?no skin off your back except finding a new job. Purchasing tokens as an employee places you at direct risk of losing your investment should the company fail.
Fear is a powerful motivator; some studies have suggested that fear of loss can be twice as powerful a motivator as the expectation of gains. Therefore, paradoxically, the employees who purchase tokens may be more incentivized to help the company succeed than early teammates who were granted tokens for free (and who probably have more upside). The late-comers have real money on the line, and fear of failure will materially affect how they approach their work!
Paradoxically, employees who purchase tokens later may be more driven to help the company succeed than early teammates who were granted tokens for free.
Once an internal trading economy for the company’s token is established, the trading could go further than just tokens-for-[insert USD, BTC, or other currency here]. Teammates could start paying each other in tokens in exchange for completing tasks or helping out on a project. Some examples might be:
- If I don’t want to do a specific task that I think is tedious, I could pay you in company tokens to do it for me.
- I take a vacation, and I pay you as thanks for covering my duties while I’m gone.
- A manager, after working on a successful project with a team, could give tokens to each member of the team as a way of saying “job well done”.
- High-level employees could stake tokens on projects they’re working on, with the staked tokens distributed to the team after the project is completed. (This starts to look like what Colony is doing.)
There’s a fine line to walk with these kinds of payments, and they’d require transparency and supervision. Since these payments would be in tokens and not dollars or other cash, all of it would be traceable on the blockchain and visible to anyone at the company. That transparency should help keep the system from becoming nefarious or harmful to the team.
Standards are still evolving
There are some unknown factors to take into account here that I don’t know the answers to but are good to ponder.
There’s been a boom in tokens created via ICO’s, and most of the new companies will probably fail. For the ones that don’t, how liquid will their token be? Sure, a token for a thriving ecosystem with tons of users will be liquid, but that may not be the case for a mediocre company. If the tokens aren’t liquid, most of their benefits go out the window.
How will insider trading be policed on tokenized platforms? If employees buy or sell tokens before a major, unannounced event that materially affects token price, that is definitely a form of insider trading. However, there are currently no rules set around this by the SEC. It’s somewhat easy to imagine this being enforced if employees use centralized exchanges like Coinbase. However, what about decentralized exchanges, where transactions could be much harder to trace? Or what if an employee trades company tokens for privacy coins, which keeps her transaction anonymous?
Some of the best projects have complete transparency on team token holdings, and this is a needed first step toward effective governance. Hopefully we continue to see the industry self-regulate, so punishment for bad actors doesn’t have to come from outsiders.
Tokens have opened up a completely new avenue for incentivizing employees in a way that doesn’t exist with stock options today. Tokens are shifting benefits of late-stage companies to earlier stages, but they also create entirely new motivation systems and internal economies. Team morale and motivation is one of the most important factors in company success, so it will be interesting to watch how companies experiment to maximize the positive effects of token incentives.