The Crypto Pay Guide is a series of articles that will be authored and released by C3 over the coming weeks. Each article will cover a separate compensation topic, focusing primarily on full-time employees in the web3.
What has the Crypto Pay Guide covered so far?
In this article, we cover token granting and vesting “best practices” for web3 organizations. Considerations include:
Token compensation can be determined on a fixed-token or fixed-value basis. On a fixed-token basis, an organization targets a consistent number of tokens granted each period, regardless of price at grant date (e.g., 12,500 tokens every quarter). On a fixed-value basis, an organization targets an intended value, with the number of tokens derived from the price at grant date (e.g., $25,000 every quarter).
For web3 organizations that have not yet had an initial coin offering or token generation event (i.e., a pre-launch project), token compensation is in fixed-token denomination because a price is not yet available. When determining pre-launch token size for each employee, projects will need to consider factors such as the overall token pool and competitive ownership percentage by role, as excellently summarized by Zackary Skelly from DragonFly Capital and Robin Ji from LiquiFi.
For post-launch projects, organizations will have a publicly traded token, like equity at a traditional corporation. In this case, C3 recommends a fixed-value denomination as it aligns actual, granted value with the approved, intended value. Fixed-token denomination, on the other hand, would result in a disconnect between actual and intended value, especially amid significant market volatility.
In the example below, assume the community approves a $100,000 token grant to an employee that is awarded each quarter (i.e., $25,000 every quarter).
Fixed-token denomination results in a disconnect between the target value approved ($100,000) and actual value delivered ($130,000 in bull and $70,000 in bear) because the organization is deriving tokens based on a higher or lower grant price.
Given substantial volatility in this space, fixed-token denomination may lead to attrition during bear markets as employees are receiving less compensation than agreed upon. Alternatively, during bull markets, fixed-token denomination can lead to excessive dilution and community backlash over misalignment of approved compensation packages.
Instead, an organization should utilize a fixed-value denomination, which targets a consistent value regardless of price. In the example above, the employee delivers $25,000 worth of value to the organization each quarter and thus should be compensated $25,000 in value, no more no less. A fixed-value denomination is a good compensation governance practice because it prevents confusion between communities and participants over actual versus intended value of pay.
An organization can choose to utilize the average token price over ten or twenty days prior to grant when deriving the number of tokens from a fixed value. This would smooth out volatility from any one trading day. C3 recommends this approach, although it is administratively more complex.
For traditional organizations, granting fixed-value is near universal.
There are two types of granting practices when aligning incentives with an employee’s service period: granting “in arrears” or “in advance”. “In arrears” is the practice of awarding tokens after service has elapsed, while “in advance” is the practice of awarding tokens prior to service completion. In both cases, tokens would be subject to vesting requirements.
As an example, suppose an individual receives a quarterly token grant of $25,000 and is hired on January 1st. If utilizing an “in advance” granting approach, the employee will receive the grant on January 1st. If utilizing an “in arrears” approach, the employee will receive the grant on March 31st following completion of quarterly service. Now, suppose the price at January 1st is $5.00, which can increase to $7.50 (bull scenario) or decrease to $2.50 (bear scenario) at the end of the quarter, as summarized below:
As evident in the example above, granting “in-advance” aligns realized pay with performance over the service period because the employee’s compensation will be linked to token value on day one and their token incentives will include their contributions to the organization. When granting in-arrears, participants will miss-out on the value they have created (or, will not be held accountable for the value they have lost). C3 recommends granting token compensation “in-advance” of service. For traditional organizations, granting equity in-advance is most common.
Both pre-launch and post-launch organizations must use appropriate vesting schedules that achieve their talent objectives. A longer vesting period promotes Conversely, a short vesting retention, although an overly long schedule can limit attraction of new talent. period will attract talent, but not retain it.
Employees with greater strategic responsibilities should have longer vesting periods as they have a direct influence on the decisions that drive token return, and thus should be held accountable for those decisions. Not to mention, organizations like to retain these individuals for longer periods of time. This why it is common to see longer vesting schedules for full-time contributors, ranging from 3 to 4 years, than for part-time contributors (6 months to 2 years).
C3 recommends organizations regularly benchmark their vesting practices relative to competitors to ensure continued alignment. Vesting practices are generally consistent over time, although unique market-wide factors (like talent shortages) can change practices quickly. Vesting practices among web3 organizations are generally aligned with those at traditional companies and web2 start-ups.
If an organization takes a less frequent granting approach (read more below), a pro-rata vesting schedule (i.e., portion vesting every year, quarter) can reward employees on an ongoing basis over the service period. If an organization takes a more frequent granting approach, cliff vesting each grant ensures ongoing retention and is administratively less complex.
For pre-launch projects, lockups also affect the ability for an employee to sell tokens, generally for one year.
An organization must also consider how often they intend to grant token compensation to each employee. Below documents a range of prevalent grant frequency practices:
When deciding a grant frequency, web3 organizations must tradeoff upside with attrition risk. A front-loaded or annual granting approach will provide the greatest upside, but only when the token appreciates in value after grant. This scenario would be most attractive to the participant. If token price decreases, or a bear market occurs, the organization risks employee attrition because most of their tokens are worth substantially less (read more about “realizable compensation”).
Generally, incentives tied to volatile prices should be granted more frequently, similar to how an investor would dollar-cost average their capital. It is impossible to predict future market conditions, especially in crypto, so a frequent granting approach protects the organization from exogenous factors affecting their employee’s compensation. However, organizations also need to attract web3 talent with upside, so a front-loaded grant may also be required, especially for new hires familiar with the web2 compensation model.
To provide upside while managing price volatility, a balanced granting approach could be considered, which would combine a front-loaded grant for a portion of incentives (i.e., new hire grant) and a frequent grant for the remaining portion (i.e., regular award). This approach would balance the tradeoff between upside potential (attraction) and attrition risk (retention).
Suppose an individual’s annual token grant is $100,000, or $300,000 for three years of service. Below is the number of tokens granted under a front-load, annual, quarterly, and balanced approach. The balanced approach grants half of the awards over the three-year period (i.e., $150,000) in a front-loaded manner and the other half quarterly.
During bull markets, the less frequent approach (front-load or annual) results in the most ending value realized for the participant, while the quarterly approach results in the least. Intuitively, this is because token price increases over time, so the derived number of tokens in future grants is lower. A balanced approach splits the difference.
During bear markets, the opposite is true, as expected. The more frequent approach (quarterly) results in the most ending value realized for the participant, while the front-load and annual approach results in the least. Again, a balanced approach splits the difference.
Three-year periods of continued growth or decline may be unlikely, so let us look at a more realistic approach. Below assumes volatile markets during the three-year period. In this case, there is less differential in approach in the ending value of tokens for the participant.
The exhibit below summarizes the pros and cons of each granting approach:
A front-loaded approach provides the most upside in a bull market, which is attractive for new talent, but risks attrition in a bear market. It also may lead to a feeling of unfairness internally among the organization’s employees. This is because the value of the front-load grant will be highly contingent on the hire date of the employee. If the participant joins during a bear market, then they will likely realize significant value from their front-loaded grant, while a participant joining during a bull market may see the value of most of their compensation fall dramatically. This may cause misaligned incentives and varying appetites for risk among employees.
A more frequent approach takes the opposite stance. It provides less upside during bull markets, but limits attrition risk during bear markets and it is a fair approach internally.
It is impossible to predict future market conditions. Crypto continues to be subject to intense market volatility often caused by exogenous factors, like regulatory developments, that are outside the participant’s control. Any one approach will likely result in a “better outcome” for the participant over any time period, but the organization must also consider the risks associated with using one approach. C3 recommends a balanced grant frequency because it protects the organization from extreme market conditions and provides the participant with a meaningful amount of upside and stability.
The granting decisions highlighted above are often overlooked. A web3 organization that takes the time to evaluate each consideration will have a well-designed framework for token compensation for its participants, thus putting the organization at a competitive advantage.
Generally, C3 recommends web3 organizations grant their employees tokens on a fixed-value basis and in-advance of service. Vesting provisions should be aligned with market based on the role, and grants could be made both upon hire and on a frequent basis to mitigate pay volatility.
The Crypto Pay Guide is a series of articles that will be authored and released by C3 over the coming weeks. C3 is the world’s first Crypto Compensation Consulting group.
We advise crypto organizations and communities on compensation levels, incentive design, and governance practices. We have experience advising both large public corporations and small technology start-ups.
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