The Employer’s Guide to Token Compensation

As a growing crypto company with employees from around the world, ensuring everyone in your organization is motivated to achieve the goals of your project is integral to your success. To get this alignment in place, it becomes necessary for you to pay your employees with your project’s tokens.

Yet, many organizations are also becoming extremely careful of rising compliance requirements from regulators around the world. Unlike the old days where the legality and tax treatment of token compensation were gray areas, most jurisdictions today have differing laws and interpretations we must all abide by.

How can growing organizations pay employees around the world with tokens and stay in compliance? In this article, we will provide a high level guide of how to provide token compensation compliantly.

Why Pay Employees in Tokens?

Similar to how equity has become a dominant incentive mechanism in Silicon Valley startups, ‘equity’ in the underlying blockchain is becoming a key tool used to align the interests of employees with the project. 

Token compensation (also commonly referred to as ‘crypto compensation’), when done well, can create a lot of benefits to your organization:

• Get your employees vested into your project’s success: Providing employees with a direct financial stake in your project’s ecosystem will foster a sense of ownership and motivation as they become a bona fide “stakeholder”
• Give your employees a huge upside potential: The potential upside of holding these tokens also acts as a huge financial motivator which ties all their work on the project into very palpable financial gain. Many early employees in successful crypto projects have often become millionaires.
• Operationally easier to transfer: Unlike shares, paying employees in tokens is as easy as signing in to your organization’s crypto custody solution and signing transactions to a list of wallets.

Crypto Compensation Trends

Most native crypto organizations pay some or most of their compensation to employees in crypto, mixed in with fiat and possibly equity. For the purpose of this article, we must distinguish the common types of compensation in the crypto space:

• Fiat Compensation is compensation made using fiat currencies such as the US Dollar (USD) and Great British Pound Sterling (GBP).
• Equity Compensation is compensation made using shares of a company.
• Token Compensation is compensation made through any cryptocurrency, such as through your project's own tokens or other popular tokens like Bitcoin (BTC) or stablecoins like USD Coin (USDC).

Projects will often engage in a mix of both forms of token compensation, fiat compensation and possibly equity compensation; for example, a project may pay out their contributors 30% in local fiat currencies, 20% in USDC stablecoins, 20% in their project’s native tokens, and 20% in equity.

Projects will also have different implementation requirements for their compensation plans, such as the usage of options or grants for tokens and equity in particular.

Your choice of how to find the right mix of these compensation methods and how to administer them is extremely important to ensuring you have a great foundation for a motivated and well-rewarded team.

How many tokens should I set aside?

How you should apportion your tokens for your employees highly depends on your goals as a project, and should be one of the first considerations of the project when building its tokenomics.

It is not an understatement to say that much of a project’s success lies in its people. When projects set up their tokenomics, one of the first things projects figure out is how many tokens it reserves to incentivize all of its market participants. Your employees count as a significant part of the tokenomics equation.

In general, it’s extremely important for you to understand the ramifications of how you distribute tokens to employees:

• What is the pool of tokens you have reserved for compensation?
• Are you planning to offer equity, cash and benefits in addition to the token?
• What is the perceived value of the token to you and your employees?
• How liquid is your token in the open market?
• How will your token compensation plan affect the token’s price or liquidity?
• What mechanisms currently exist to stabilize your token’s price?
• Is there a lock-up period? How long is it?

This is in no way an exhaustive list, and there is no one-size-fits-all approach. Every organization’s token compensation model is different just as no two projects’ tokenomics are the same.

How to Set Up Token Compensation

To begin setting up token compensation, it is essential to have a basic understanding of equity-based compensation and the associated tax implications, as token compensation is treated very similarly in every jurisdiction. This knowledge serves as a foundation for comprehending the complexities and considerations of token compensation.

Generally, when employees receive equity, they are subject to taxation on the fair market value of the equity when a ‘taxable event’ occurs. However, the occurrence of a taxable event and its taxable amount will differ depending on the mechanism of your equity compensation plan and the country where the compensation plan is administered. 

Employers have specific responsibilities when it comes to tax withholding and reporting for employees receiving token compensation. These responsibilities will change depending on the tax status of the employee (full-time vs contractor, resident vs non-resident, etc).

The complexities are endless, but this basic context will equip you with enough information to understand the deeper considerations of implementing an international token compensation program.

1. Decide How to Classify Your Employees

The classification of your employees significantly affects what responsibilities you have as an Employer administering token compensation.

In general, it is important for you to decide early on if you want to have your employees as “Full-Time Employees” or “Independent Contractors”.

• Full-Time Employees incur more employer obligations, but creates a more positive employee experience. 
• Independent Contractors are the opposite, as Employers have less obligations but the employee will be generally responsible for their own taxes, benefits, pension, etc.

However, it is crucial to ensure proper classification to comply with labor laws and avoid misclassification penalties.

2. Get Legal Classification for Your Token

The classification of tokens as securities can subject you to additional compliance requirements, such as registration with securities regulators, licensing requirements or adherence to specific disclosure obligations.

It is important for you to gain legal clarity on how your tokens will be treated in every jurisdiction you have employees in. Commonly, this means retaining services of top law firms who will advise you and issue legal opinions or memos.

3. Design and Optimize Compliant Token Agreements

Token agreements involve navigating through complex legal frameworks, including contract law, securities regulations, and financial regulations as described in the previous section.

New laws, guidelines, and interpretations are being introduced somewhere in the world every week, making it challenging to stay up-to-date and ensure compliance with the latest regulations. Organizations must invest time anto avoid potential regulatory pitfalls in their token award agreements.

Token agreements must also include details on vesting schedules and valuation methods. Designing fair and compliant vesting schedules that align with the organization's goals while considering legal requirements can be complex. Similarly, determining the appropriate valuation method for tokens can be challenging, as it may impact taxation, accounting, and regulatory compliance.

NOTE: Token price volatility is a common concern for organizations implementing token compensation models. To mitigate the risks associated with price fluctuations, companies can consider using stablecoins or pegging token values to a basket of currencies or assets. Additionally, organizations may choose to implement automated mechanisms for adjusting token allocations based on market conditions, or allow employees to convert tokens to fiat currency at predefined intervals.

These Token Grants should also address the treatment of tokens upon termination of the agreement. Determining how tokens should be handled, whether they should be returned or forfeited, and considering any legal obligations related to termination can become a multi-faceted discussion depending on your goals.

Are you ready to streamline employment and compensation for your Web3 organization?

Let’s Talk

4. Set Up Your Crypto Payroll Operations

Now it’s finally time to actually send out the tokens, but wait, is your Finance team ready to sign transactions, track transaction data, decipher the fair market value and file forms for your employees?

Being compliant with token compensation will mean that employers must keep track of data and be aware of how that data is used to derive the taxable value of the cryptocurrencies. Even for independent contractors, employers are obligated to fill out forms that will require accurate records of the transaction.

Employers must also factor in the operational overhead needed to comply with regulatory requirements, such as Anti-money laundering (AML) and know-your-customer (KYC) requirements are crucial considerations when dealing with token compensation. Ensuring compliance with these regulations requires robust processes for identity verification, transaction monitoring, and reporting.

As regulations continue to evolve, Finance and Legal teams must also be proactive in seeking out and complying with these new laws.

5. Continuous Employee Education and Guidance

By creating transparency around the operations and intent of your token compensation plan, employees can build trust in you and the value of their token grants.

This includes clear explanations of eligibility criteria, vesting schedules, lock-up periods, and any other relevant terms and conditions. In our experience, we also find it useful to explain their income tax calculations, and the relevant laws in their jurisdiction. 

The design and optimization of international Token Grant agreements is a bleeding edge subject in the field of law, compliance and cryptocurrency. As things continue to change, continuous education is essential. 

By providing comprehensive education and guidance, we can empower employees to make informed decisions about their token compensation effectively. This not only enhances employee satisfaction but also contributes to a culture of shared ownership and responsibility, aligning individual and organizational success.

Understanding Tax Implications

Managing token distributions and tax withholding obligations can be a complex and time-consuming task, but it is the most critical part of the process. Distributing tokens to employees triggers various obligations, including but not limited to recording tokens in payroll, withholding taxes, adhering to reporting procedures, and following legal settlement schedules. 

Much of this distribution process requires complex tax calculations and cannot be automated via smart contracts. Some organizations have in-house teams handling these processes via spreadsheets or they work with a dedicated token grant administrator. Those that have done this work in-house have had to learn over the course of a year or longer how to make the initial grants, and then continuously adapt the token compensation program as the business, workers, technology and regulations change.

Conclusion

The implementation of token compensation presents employers with unique challenges in terms of operations, compliance, and risk management. However, by adopting a comprehensive approach to designing and administering token compensation, organizations will be able to navigate these challenges effectively.

At Toku, we understand and specialize in the design, implementation and execution of a proactive approach to token compensation administration. Leading organizations like Protocol Labs and Gnosis choose Toku to handle their international token compensation programs.

Make your Token Grant administration simple. Skip out on those sleepless nights by working with Toku today.