What has the Crypto Pay Guide covered so far?

1. Objectives & Compensation Risk

2. Compensation Model

3. Compensation Process

4. Compensation Governance

5. Token Grant Practices & Vesting

***

In our last article, we summarized best practices when granting token compensation, such as grant denomination, service timing, vesting, and frequency. In this article, we cover the importance of performance-based pay and the considerations when designing such incentives.

Tokens / Restricted Token Award (RTA)

Before we dive into performance pay, it is important to cover the current state of web3 token incentives. The most common type of incentive is a service-based token which vests over a pre-determined period. Since we will cover many different types of tokens (e.g., performance tokens), C3 will define this type of incentive as a “restricted token award (RTA)” based on the universal use of a similar equity incentive type among traditional organizations, the restricted stock award (RSA).

An RTA is the simplest and most common token incentive type, although the least effective at meeting key talent objectives, such as attraction, motivation, and accountability. A RTA is easy to understand from the participant’s perspective and achieves long-term retention. In theory, RTAs should incentivize the participant to grow token price, although, in practice, few participants understand the performance drivers of token price, especially given exogenous market factors that affect return. RTUs also do not provide leverage because no performance goals are set, which limits attraction, accountability, and motivation.

To create a robust incentive plan that achieves all talent objectives, traditional companies utilize other performance incentives, such as annual bonus plans, stock options, or performance shares, which are still uncommon in web3.

Importance of Performance Pay Performance

Performance pay is a critical tool available to communities, investors, and protocols to achieve the following talent objectives:

1. Retention

2. Attraction: compensation should have sufficient upside potential for achievement of stretch performance goals, thereby attracting talent seeking wealth opportunities.

3. Motivation: communities and investors should utilize compensation as a tool to motivate behaviors and indirectly drive token return.

4. Accountability: performance pay ensures that employees are rewarded when tokenholders are rewarded. This creates a pay-for-performance model that promotes accountability and fits well within the ethos of web3.

There are many types of performance pay incentives to choose from and there are a variety of different ways to structure any one incentive type. Generally, for traditional organizations, there are three types of common performance pay vehicles, each excelling at a different talent objective via their design features.

It is important to note that although restricted stock is variable, it is not performance-based. The value of restricted stock is tied to a company’s stock price, but performance goals are not set such that the ultimate number of shares earned fluctuates (i.e., there is no leverage).

Bonus plans are the most common incentive type among traditional organizations because they are effective at meeting most talent objectives, albeit on a short-term basis, and are simple to understand and administer. Performance shares, although uncommon, are one of the most effective performance pay types. Performance shares are like bonus plans, except denominated in equity and measured over longer periods of time. Equity-denomination provides more leverage, thereby making them more attractive than standard bonus plans. Stock options are prevalent, especially among start-ups, and they achieve a bit more talent objectives than restricted stock, but are quite limited in design, thereby making them less effective than other performance pay alternatives. In future articles we cover these incentives in more detail and summarize how web3 organizations can mimic them with token incentives.

Performance Pay in Web3

There are more tools that make performance pay more feasible (and attractive) for web3 organizations now than ever before, yet it is still rare in practice, likely because of historic precedent:

• Performance goals were difficult to define and measure. In the early days, web3 organizations were unsure about which performance metrics drove token return. Today, there is greater understanding, structure, and definition around key protocol measures that will drive performance. There are also plenty of third-party tools that measure such goals, thereby ensuring independence measurement.

• Performance goals were difficult to achieve. Volatile market conditions lead to uncertain performance achievement, which limits the overall effectiveness of performance pay. Volatility makes it difficult to set reasonable performance goals given error in estimation. Volatility is not going away, but it can be managed through thoughtful design (read more below).

• Undeveloped compensation governance processes have limited the ability to design, approve, and implement performance incentives. Compensation governance is constantly improving, and the prevalence of Compensation Committees and councils is increasing in web3. These entities provide the flexibility to work with outside experts to design performance incentives. After development, the committee can submit the plan for approval to the community. At the end of the cycle, the committee can provide an update on performance tracking and achievement, while also submitting the next plan for approval. This system of accountability ensures that there is sufficient rigor in the performance targets set by the protocol. A protocol should ensure it has an appropriate governance mechanism in-place that allows the community to regularly evaluate performance pay programs.

Looking ahead, we believe the use of performance pay will increase in web3 because it is an important mechanism to align the incentives of contributors with tokenholders, which fits within the ethos of decentralized compensation, and it achieves talent objectives that are otherwise unmet with time-based tokens. Additionally, unlike traditional corporations, web3 organizations can be creative on the design of performance tokens by mixing-and-matching traditional design types . This allows for greater customization.

Performance Token Design Considerations

The list below outlines major features web3 organizations and communities need to consider when designing performance incentives:

• Payment Type: will the incentives be paid in stablecoins or native tokens? Stablecoins will limit upside and thus the attractiveness, although it will protect the participant from downside risk.

• Performance Period: what is the time period that performance be measured over? A longer performance period will promote retention, although limit the accuracy in setting reasonable goals given market volatility.

  A performance period is not the same thing as a vesting period. An incentive can have a shorter performance period (e.g., 1 year), but a longer vesting period (e.g., 3 years) to ensure retention following performance achievement.

  To manage market volatility and performance achievement, a protocol can shorten the performance period such that goals are set on a more frequent basis. A shorter performance period limits error when setting goals and ensures performance cycles can be reset frequently.

• Leverage/Payout Range: how is leverage incorporated within the incentive? Does the participant receive less/more tokens for under/over-achievement of target goals? What is the range of payouts? Communities should ensure that they are not providing “free leverage”. Upside should be earned when stretch goals are met.

  Another way to mitigate volatility is to tweak the performance goal ranges. For example, protocols can set a flat payout around target. Or, set wide threshold and maximum goals to ensure a payout at either end.

• Metrics: Determining which metric will reward contributors is often the most important consideration because it affects what type of incentive will be used.

  When selecting a performance metric, web3 organizations should make sure it meets the following expectations from the community and the participant:

Ideally an organization achieves all expectations via appropriate metric design:

• Metric Type: what metric will be used to determine payout? Will the metric be market-based (e.g., token price) or operating-based (e.g., Total Value Locked)?

• Metric Measurement: will the metric be measured on an absolute basis or on a relative basis?

  By measuring performance relative to similar peers, a protocol can strip away exogenous market factors and focus on value-added performance (more on that in later articles). Of course, this incorporate additional complexity.

• Goal-Setting: what are the appropriate goals that determine payout at target, below target, and above target?

Finally, it is important to note that performance pay is not for every type of employee. Generally, employees with greater risk profile should have a greater percentage of total pay in performance incentives. As you move down the risk profile, LTI should focus more on retention, and less on performance.

In our next articles we will cover the performance pay types seen among traditional corporations and how similar constructs can be used for web3:

• Bonus Plans (+Coordinape)

• Stock Options

• Absolute Performance Shares

• Relative Performance Shares

And, then we get creative by idealizing how incentives can be different for web3.

C3 can assist communities, protocol leaders, and investors design appropriate performance tokens.

***

*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.

Please read more about our firm and services on our website. If you are a leader, investor, or community member who would like to work with us, please contact us at info@c3.email or via Twitter.

Follow us to stay up to date on future installments of the Crypto Pay Guide!

What has the Crypto Pay Guide covered so far?

1. Objectives & Compensation Risk

2. Compensation Model

3. Compensation Process

4. Compensation Governance

***

In this article, we cover token granting and vesting “best practices” for web3 organizations. Considerations include:

1. Denomination - are awards measured in number of tokens or target value?

2. Service Timing - is token compensation made for completed or prospective service?

3. Vesting - when is token compensation earned?

4. Grant Frequency - how often is token compensation granted?

Denomination

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.

Service Timing

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.

Vesting

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.

Grant Frequency

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.

In Conclusion

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.

In our next article, we cover best practices when designing performance pay incentives.

***

*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.

Please read more about our firm and services on our website. If you are a leader, investor, or community member who would like to work with us, please contact us at info@c3.email or via Twitter.

Follow us to stay up to date on future installments of the Crypto Pay Guide!

What has the Crypto Pay Guide covered so far?

1. Objectives & Compensation Risk

2. Compensation Model

3. Compensation Process

***

In our second article, “Compensation Model”, we summarized the prevalent model used among web3 organizations and we covered the unique market factors that make compensation challenging. In our third article, “Compensation Process”, we summarized the retentive power of having a well-designed compensation governance process. In this article, we combine insights and outline how a compensation model can be evaluated through a robust compensation governance process. We cover the importance of utilizing different pay components to achieve talent objectives and we outline how compensation vehicles can be reviewed within a governance framework.

Compensation Model by Employee Level

For traditional organizations, the use of a base salary, a bonus, and equity compensation is common. Bonus and equity is defined as “variable pay” because its value is subject to performance (e.g., predetermined bonus goals, token price).

The allocation of base salary, bonus, and equity compensation is defined as “pay mix”. For executives of publicly traded corporations, about 10-30% of their total pay is in base salary, 20-40% is in cash bonus, and 40-60% is in equity compensation. An organization should regularly evaluate its pay mix by employee level to ensure it is meeting its talent objectives. There is no “one size fits all” model, although organizations that use all three pay types are better equipped to accomplish their compensation goals because they will have more levers to pull.

Below is a graphic that outlines a generalized approach to allocating variable pay by employee level:

Employee level is shown on the left-hand side starting from the top of the organization (i.e., leaders) and ending at part-time employees. Each subsequent category differentiates as you move down employee level. Let us dive into the various considerations.

The graphic above is a generalized model that is common among traditional companies. Many web3 organizations do not currently adhere to this generalized model because:

• They are highly decentralized and prefer one compensation framework for every contributor. A DAO may choose to not differentiate employee pay by level to prevent indirectly establishing leadership or organizational hierarchy. This fits within the ethos of decentralized compensation although is largely still an experiment. C3 is monitoring how a lack of compensation differentiation affects a DAO’s ability to scale and attract talent.

• They do not differentiate by employee level because they do not have the data, tools, expertise, or capabilities to do so.

• They do not use performance-based pay vehicles, like bonus plans or performance tokens. This limits the effectiveness of compensation as a retentive and motivational tool, especially for leadership roles.

The lack of differentiation and performance-based pay may be partly due to an unstructured governance process that does not regularly evaluate such provisions.

Compensation Governance Design

A robust compensation governance process needs to be established to ensure accountability, regularity, independence, and fairness. A well-designed process provides flexibility to evaluate key compensation frameworks and performance-based incentives. It is recommended that protocol leaders do not review and establish pay levels for themselves. This process should instead be managed by the community.

There are three prevalent compensation governance mechanisms in use today:

1. Direct vote: a proposal is submitted that outlines proposed pay levels and the community votes on implementation. This process has the strongest link of accountability between the community and the employee, although criticisms may arise, such as: Who is submitting the proposal? How were the proposed pay levels established? Are the market competitive? Were protocol leaders involved or was this an independent process? Did compensation experts opine on the levels and design?

   A direct vote may also limit the scalability of a DAO and introduce voter fatigue as every decision must be approved by the community.

2. Community-Elected Council/Committee: The use of a community-elected council of delegates is increasing. This group is similar to a Board. Delegates are elected on a periodic basis and the council may have compensation oversight, with budgets approved by the community on a periodic basis. It is important to note that decisions can be made without a community vote, although delegates should act on behalf of the community.

3. Community-Elected Council + Direct Vote: A “belt and suspenders” approach to compensation governance. The community-elected council may independently evaluate pay levels and incentive design, but the final decision cannot be made without a community vote.

All three governance mechanisms are appropriate, although C3 believes establishing a community-elected council provides the greatest flexibility. It is recommended that the council defines its scope regularly via a community vote and conducts an election process at least once per year. An independent council is an efficient mechanism because it prevents voter fatigue and creates flexibility to address unique talent factors, especially for decisions made regarding lower-level employees.

The community-elected council and direct vote (design #3) is a great approach to address compensation for protocol leaders. This way, the protocol maintains flexibility yet ensures accountability. A community-elected council will have the ability to tap into an approved budget to engage with outside experts. The final proposal can also be submitted by the council, which maintains independence. A direct vote promotes direct oversight and accountability. If failed, the council can re-work its proposal accordingly.

The use of a council without a direct vote (design #2) can also be suitable for evaluating compensation for protocol leaders as long as the council is transparent with its decision.

A similar process is done for executive pay decisions at publicly traded corporations. The Board reviews executive pay programs with outside consultants and then recommends changes. Executive pay levels are not subject to shareholder vote, but corporations do have an indirect method of accountability via an annual “Say-on-Pay” vote where shareholders can signal approval of the Board’s overall compensation decisions. The “belt and suspenders” governance mechanism (i.e., council + vote) results in a stronger link because community members have a direct influence over the pay outcomes for protocol leaders.

If a council does not exist, a direct vote (design #1) is also appropriate for protocol leaders, but it is important that the proposal is independently evaluated by outside experts to ensure it is market competitive and fair. The outside experts can be engaged by the community via a separate proposal and can also lead the review process.

Combining Compensation Model & Process

In this section, C3 outlines how a protocol can regularly evaluate its compensation model by employee level through its governance process.

For Protocol Leaders

C3 recommends a “top-down” approach. The organization would first design the compensation program for protocol leaders and then extrapolate features to other employees. Below are generalized steps a web3 organization can take to properly evaluate its compensation model for leaders:

1. Benchmarking: The community or council can engage outside experts, like C3, to assist in benchmarking compensation levels using competitive market data. Base salaries, bonus levels, and token ownership percentages can be evaluated. Market data should include compensation information for similar jobs at traditional technology companies (both private and publicly traded), as well as crypto organizations, to the extent available.

   Generally, base salaries and target bonuses should be positioned near the market median. Positioning above or below the median is appropriate with sufficient rationale. For example, a leader who is positioned at the 25th percentile may be a new hire who has limited experience in the role. Or, a leader who is positioned at the 75th percentile may be highly tenured or may be a stellar performer. The organization’s talent strategy may also warrant above-median positioning. For example, a protocol may need to attract leadership from a traditional technology company and thus require 75th percentile pay.

   Token ownership levels should also be benchmarked. It is important to consider tenure and latest market valuation when evaluating ownership. For new hires, it is reasonable to target the 25th percentile because ownership levels will accumulate over time.

2. Developing A Proposal: After the benchmark review, communities or councils will be well-informed to develop a pay proposal with outside experts.

   Communities or councils should also work with consultants to develop incentive plans for the upcoming cycle that achieve the organization’s short- and long-term objectives. For this exercise, it is important to include protocol leaders in the conversation as they have a better understanding of the organization’s strategy and performance drivers. When developing an incentive plan, it is critical to include performance metrics that are simple, measurable, and rigorous. C3’s next articles will cover “best practices” in performance-based pay.

3. Approval: The community or outside consultant can submit the draft proposal to the community for a vote. The proposal should outline current pay levels and ownership, proposed pay levels and ownership, and rationale for any changes.

   If an incentive plan is utilized, the proposal should cover the details of the plan, such as the performance metrics, goals, and payout ranges.

Once approved, the organization can utilize the compensation model as a framework for broader employees.

Broader Employees

A similar process is conducted for other employees (i.e., non-leaders), with a couple of differences:

• Less oversight from the community: A direct vote is not entirely necessary, especially when an elected council serves on behalf of the community. Additionally, protocol leaders should spearhead the evaluation for broader employees because they have a better understanding of internal job function and performance.

  A community-elected council can periodically report on token compensation expense or dilution for the entire organization. The community will therefore have a pulse on the aggregate token granting practices. A reasonable time to report on such provisions is when the council returns to tokenholders for budget requests.

• Less variable pay: Protocol leaders can work directly with outside experts, like C3, to benchmark pay levels and ownership for lower-level employees. As mentioned above, the objectives of variable pay narrow as you move down an employee’s risk profile. Therefore, one can expect the percentage allocation to variable pay (i.e., bonus and tokens) to also decrease.

  Although the mix of variable pay may change, the overall design of incentives should be consistent with the design for protocol leaders so everyone is working towards the same goal.

A well-designed compensation governance process can go a long way because it gives the organization flexibility to evaluate compensation models by employee level.

Our next article will token granting best practices, and subsequent articles will cover performance-based tokens.

***

*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.

Please read more about our firm and services on our website. If you are a leader, investor, or community member who would like to work with us, please contact us at info@c3.email or via Twitter.

Follow us to stay up to date on future installments of the Crypto Pay Guide!

What has the Crypto Pay Guide covered so far?

1. Objectives & Compensation Risk

2. Compensation Model

***

In our last article, we summarized the compensation model used among web3 organizations, which consists of a base salary and/or a large allocation to token compensation. Just like it had for start-ups, this compensation model will attract talent to the crypto industry as individuals seek significant upside from token compensation. However, the retentive effects from the start-up compensation model may be less translatable for crypto organizations. This is because token compensation is liquid (i.e., tradable) meaningfully earlier than start-up equity and token compensation is subject to shorter vesting periods. Crypto markets are also very volatile, which drives realizable pay volatility (read more here).

The following are potential adjustments to the crypto compensation model to better address pay volatility and ensure retention of employees long-term:

1. Establish a regular, independent compensation review process using relevant market data (covered in this article)

2. Provide an appropriate mix of at-risk, variable pay

3. Implement token granting best practices

4. Utilize performance tokens

Compensation Process

“Compensation process” refers to the governance mechanisms in place that review an employee’s pay and token ownership levels, as well as the overall design of incentive plans. A compensation process should address the following questions:

• How often does the organization evaluate an employee’s pay levels and token ownership relative to market? How often does the organization implement changes?

• Who makes the compensation decisions? Is this a transparent process?

• Is market data used to benchmark an employee’s pay and ownership?

• Does the company document its compensation governance process with community members and investors to ensure accountability?

Although these questions may seem mundane or administrative, an established compensation process is critical so communities are heard and employees are fairly compensated, which in turn will promote retention.

We can learn a lot from publicly traded corporations as they have evolved their compensation governance process over decades and are subject to constant regulatory scrutiny. Corporations are managed by executives who are kept in-check by the Board of Directors, which of course represent the interest of shareholders. The following is a generalized compensation process for a publicly traded corporation:

The above compensation governance process is well-designed because it meets the following four objectives:

1. Accountability

2. Independence

3. Regularity

4. Fairness

The crypto industry can leverage and improve on such a design, but organizations should walk before they run and ensure the process fits within their current governance structure.

Accountability

It is crucial to have a compensation process with checks and balances so all parties are held accountable for the decisions they make. The compensation process at a publicly-traded corporation establishes a system of accountability. Shareholders elect board members to oversee the decisions made by executives. To hold board members accountable, shareholders review and approve the company’s executive compensation practices via the Annual Proxy Statement.

This system of accountability was created over decades, and we do not expect the crypto industry to establish such a process overnight. As governance structures evolve and DAOs scale, it is important to establish checks and balances wherever possible.

How can accountability be incorporated? Many organizations have elected community members or delegates that serve on a council, similar to a Board of Directors, with the intent of acting on behalf of tokenholders. C3 believes that this group should have oversight over key compensation decisions, such as incentive plan design or the pay levels for protocol leaders. For scalability, we do believe it is important for protocol leaders to have some independence in hiring and determining pay levels for lower-level employees. If an elected council does not exist, communities themselves can hold leaders accountable, although we advise that communities engage independent third-parties for compensation expertise (see “Independence” below).

Additionally, it is important for the protocol to be transparent with their compensation practices so leaders and/or council members are held accountable. We will likely see the prevalence of documents disclosing pay practices to increase, especially as regulators are more active in this space.

Independence

Compensation is a sensitive topic. It is crucial for communities to engage with an independent third-party, like C3. Third-parties can limit emotional decision-making by serving as a middle-man between protocol leaders and communities. Also, independent third-parties are experts that can advise protocols on complex compensation issues that may be outside the scope for most leaders.

Most protocols do not have HR professionals in-house that have the capability to review compensation levels. Even if HR professionals are hired, they are not independent. Protocol leaders should not be proposing their own pay adjustments and putting it up for a community vote as this can cause backlash.

Regularity

A compensation process needs to have a regular cadence. Corporations conduct their process annually. Crypto organizations should guarantee compensation decisions at least once per year, although, given the fierce crypto talent market, compensation can be evaluated semi-annually or quarterly to foster market alignment.

Frequent market review confirms that employees’ pay and ownership is aligned with the market, which in turn promotes retention. A frequent and regular compensation process also creates a nimble organization that can quickly respond to exogenous talent factors. For example, during bear markets, employees may see the value of their compensation drop substantially. Having an established and frequent compensation process allows the organization to consider a response under normal cadence, without approaching the community with one-time proposals.

Fairness

A fair process requires the use of market data to benchmark pay levels and ownership. As an industry, we must move away from crafting offers based on what “seems right” or what we have read on Twitter. Instead, we must rely on appropriate and defendable compensation data.

Ideally, this compensation data would come from independent third-party sources that focus on the crypto industry. However, a crypto-specific resource does not yet exist (although C3 intends to develop a robust source through our client work). Until a crypto-specific source is created, we must rely on traditional resources when crafting offers or evaluating pay levels, such as:

1. Compensation at prior role, assuming it is reasonable.

2. Compensation for a similar job at a traditional technology company or start-up.

Benchmarking against relevant compensation data promotes fairness. The employee is fairly compensated for their role, which nurtures retention, and the organization and community are certain they are spending an appropriate amount on talent.

In Conclusion

Retention is frequently addressed via adjustments to compensation levels or incentive design, thus organizations often overlook the retentive power of having a well-designed compensation review process. A robust compensation process should address accountability, independence, regularity, and fairness, which in turn will promote employee retention. This can be the first step for many web3 organizations as they continue to evolve their governance structure.

Of course, this is not the only approach a web3 organization can take to improve retention long-term. The following additional measures will be covered in future installments of the Crypto Pay Guide:

1. Provide an appropriate mix of at-risk, variable pay

2. Token Granting Best Practices & Vesting

3. Performance Tokens

***

*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.

Please read more about our firm and services on our website. If you are a leader, investor, or community member who would like to work with us, please contact us at info@c3.email or via Twitter.

Follow us to stay up to date on future installments of the Crypto Pay Guide!

What has the Crypto Pay Guide covered so far?

1. Objectives & Compensation Risk

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The following article defines a “compensation model”, summarizes the model used among web3 organizations, and addresses its pitfalls. C3 also introduces some recommended changes.

Compensation Model

C3 defines a “compensation model” as the pay components used, as well as the percentage allocation of each component (i.e., pay mix). There are three types of pay components commonly seen among traditional corporations:

1. Base salary: Provides guaranteed, fixed compensation. Base salary level should reflect the individual’s competencies, responsibilities, and accountabilities. Thus, base salaries are higher for individuals with greater scope.

2. Annual bonus: Represents variable pay, usually expressed as a percentage of base salary. Payout is typically in cash based on achievement of pre-determined annual performance goals.

3. Equity: Awarded in restricted stock or stock options, or tokens for web3 organizations. Grant size could be set as fixed dollars (e.g., $100,000) or fixed number of shares/options/tokens (e.g., 200,000 tokens). It is considered variable pay since the value is tied directly to the price of the equity vehicle/token.

An organization should regularly evaluate its compensation model by employee level to ensure it is meeting its talent objectives. There is no “one size fits all” model, although organizations that use all three pay components are better equipped to accomplish their compensation goals because they will have more levers to pull. For example, an organization that wants to improve retention can allocate a greater percentage of pay to service-based equity that vests over several years. Or, an organization that wants to motivate its employees towards achievement of short-term goals, such as a project roll-out or revenue growth, can allocate a greater percentage of pay to its annual bonus.

Below are important considerations when developing an appropriate and fair compensation model:

• At-Risk Compensation: Percentage allocation to variable pay (i.e., annual bonus and equity incentives) should increase as employees have more strategic responsibilities and oversight. Base salaries for corporate executives, for example, account for less than 30% of their total compensation – the remaining value is allocated in variable pay, such as an annual bonus and equity. More variable pay ensures incentives are directly linked to company performance, which creates a pay-for-performance model where employees and share/tokenholders realize value at the same time.

  For lower-level employees, base salaries should represent a greater portion of total pay because these individuals have little to no impact on strategic decision making. These individuals also tend to be more risk averse as they have not built-up sufficient wealth.

• Retention: Organizations need an appropriate mix of cash and equity/token incentives. Cash is needed as it protects the employee from decreases in equity/token value, particularly during bear markets. Equity/token compensation is needed, especially for leaders, to promote retention via time-based vesting and to ensure alignment with share/tokenholders.

• Motivation: Organizations should use compensation as a tool to accomplish their short- and long-term objectives via performance-based pay components, like annual bonuses and/or performance-based equity.

• Simplicity: Programs should be easy to understand and relatively stable year-over-year.

The Crypto Compensation Model

The compensation model used among crypto organizations today is similar to the one used among technology start-ups. This makes sense considering venture capitalists and early crypto employees are familiar with investing in and working at start-ups.

The start-up compensation model consists of a base salary and an up-front grant of equity, typically stock options, which generally vest over three to five years. Start-ups utilize equity compensation in lieu of an annual cash bonus or a higher base salary. The equity award is often granted upon hire, although an employee may receive subsequent grants (i.e., top-up/refresher grants) in future years based on tenure or performance. The equity is also granted at a favorable price which allows the employee to realize significant upside potential upon a liquidity event, such as an IPO or transaction.

For the start-up, heavy use of equity allows for compensation without burning cash, which can instead be used to grow the business. More equity compensation also promotes retention and ensures employees work towards a successful liquidity event. The downside of this model is that employees lack liquidity prior to an IPO, which may last seven or more years, depending on hire date. If an IPO is delayed or unlikely, lack of liquidity can force employees to seek opportunities elsewhere. Lack of liquidity may also make hiring risk-averse employees difficult, like new graduates, who may value higher cash compensation.

Overall, this compensation model has been successful for technology start-ups. The major technology firms that went public (e.g., Facebook, Uber, Netflix, etc.) had early employees realizing life-changing, generational wealth from their equity, partly because it was granted at low prices. These opportunities have caused others to try their luck at technology start-ups, creating a circular effect which grew the talent pool and lead to countless of companies being built.

Currently, a similar compensation model is present among crypto organizations. Employees receive an annual base salary and/or token compensation. Annual bonuses are also less prevalent as revenue/cash generation is less common. Token compensation represents the pay component with the most earning potential.

The high allocation to token compensation will likely attract talent to the crypto industry because individuals recognize the high earning potential. We can already see this happening - a plethora of tech talent is choosing Web3 over traditional routes in an attempt to realize such gains.

Although the talent pool will likely increase, other effects are less translatable. More specifically, crypto organizations will not as effectively retain and motivate their employees with the start-up compensation model. This is because crypto organizations differ from start-ups in two important regards:

1. Liquidity: tokens are liquid meaningfully earlier than start-up equity and crypto markets are very, very volatile, which results in pay volatility (read more below).

2. Governance: web3 organizations have a stronger relationship with communities than start-ups and are thereby subject to more compensation transparency and scrutiny. Thus, crypto employees need to be held accountable with performance-based pay elements (read more below).

Liquidity

Tokens are liquid (i.e., tradable) meaningfully earlier than start-up equity. The average start-up takes about seven years to IPO, while an initial coin offering (crypto’s version of an IPO) is one of the first steps a web3 organization takes. This is because a native token is required for product use and/or community involvement.

Liquidity has a direct effect on an employee’s realizable compensation. Realizable compensation is hypothetical and represents the perceived value of compensation at any given time. For example, suppose one was awarded 10 tokens at a $5.00 price, the realizable value on day 1 is $50. Then, on day 5, suppose each token appreciates to $10.00 . The total realizable value of the tokens is $100, or two times the value at grant. Realizable pay does not consider vesting periods because it is the perceived value to the employee at any given time. Even though the tokens are unvested, the employee perceives their compensation to have doubled in the example above.

Realizable compensation is important because it affects retention. Intuitively, if an individual’s realizable compensation is 10x their granted value, then they are less likely to leave a company. If an individual’s realizable compensation is one-fifth their granted value, then they have little incentive to stay, regardless of vesting.

Start-ups take a two-pronged approach to retention via their equity:

1. The lack of liquidity retains an employee. Even if the employee was fully vested in their equity, they would not be able to realize that value until a liquidity event occurs, like an IPO or transaction, which typically takes many years.

2. Realizable compensation is positive and stable through an IPO. This is because the employee receives equity at a favorable, low price and the equity has plenty of runway to appreciate given an IPO takes many years. Their realizable equity compensation is also stable because it is not tradeable and outside firms only periodically value it (e.g., every quarter, every year). These valuations also do not incorporate exogenous market factors or intangibles that public markets would otherwise consider

This two-pronged approach does not translate to web3 organizations because liquidity comes sooner. Unlike startup equity, tokens are publicly traded and have an immediate realizable or perceived value. For pre-launch projects, tokens are awarded at favorable prices, therefore realizable compensation at ICO may be above granted value. If a token’s price decreases following an ICO, realizable token compensation will be less than the intended grant value. For post-launch projects, tokens are awarded at spot. The crypto industry is subject to substantial price volatility which in turn causes an employee’s realizable token compensation to constantly change, thus affecting retention.

The early days for any organization are often the most tumultuous. A start-up can make mistakes and learn from them, all while being left unpunished by markets because their equity is not traded and public disclosures are not made. Web3 organizations do not have this flexibility. Since their token is traded, web3 organizations are subject to immediate market criticism. Mistakes will be made – but markets will react, and thus token prices will fluctuate accordingly.

Token price volatility will be further exacerbated by exogenous market factors outside of the organization’s control, which tend to be quite strong for the crypto industry as regulatory developments are ongoing. During bear markets, employees will see the realizable value of their tokens decrease. Employees may seek opportunities elsewhere, particularly at firms who are willing to spend more on talent, offer more cash compensation, or provide more upside. During bull markets, employees will see the realizable value of their token compensation increase. For employees with unvested tokens, a bull market promotes retention. However, for employees with vested tokens, a bull market can incentivize them to sell tokens at a profit and seek opportunities at firms with more upside or where cash compensation is offered.

Finally, the value of an employee’s tokens is highly contingent on the hire date. For a start-up employee, the value of untraded equity is relatively stable, so all employees begin from a similar starting point and are targeting the same goal – an IPO. For crypto organizations, the value of their tokens is contingent on the price upon hire. An employee that is hired during a bull market receives less tokens than an employee that is hired during a bear market. This can lead to unintended consequences, differing incentives, unfairness, and may cause employees to change jobs mid-cycle to receive beneficial token awards at other firms.

How can the crypto compensation model better address pay volatility caused by immediate liquidity and volatile markets? C3 recommends the following approaches to mitigate pay volatility, which will be covered in detail in future articles:

• Ensure an independent compensation review process with relevant market data

• Provide an appropriate mix of at-risk, variable pay

• Grant tokens more frequently

Governance

As stated earlier, because tokens are traded immediately, web3 organizations are subject to greater market criticism than traditional start-ups. Web3 organizations also have a decentralized and transparent governance structure where tokenholders have a strong influence on the organization’s overall operations. This decentralized governance structure creates a strong link between tokenholders and the employees.

Despite this relationship, very little progress has been made on aligning incentives of tokenholders and employees. Yes, both tokenholders and employees are motivated by an increase in token price. But, what happens during prolonged bear and bull markets? How do tokenholders ensure employees are working towards financial or strategic goals that continue to push the organization forward despite exogenous market factors?

Crypto’s governance structure is more similar to that of a publicly-traded corporation than that of a start-up. Therefore, we can leverage compensation mechanisms present at corporations, which better-align the incentives of the employee with that of the shareholder.

How can we ensure accountability of leaders via compensation and align incentives with token holders? C3 recommends the following approaches, which will be addressed in future articles:

• Utilize performance-based pay components, including performance tokens

• Implement token ownership guidelines to ensure leaders are holding tokens

• Promote transparent compensation reporting

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*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.

Please read more about our firm and services on our website. If you are a leader, investor, or community member who would like to work with us, please contact us at info@c3.email or via Twitter.

Follow us to stay up to date on future installments of the Crypto Pay Guide!

Objectives for the Crypto Pay Guide

1. Trailblaze. Unfortunately, very little has been written on this topic thus far. There are plenty of resources covering compensation best practices for start-ups, private companies, and corporations, and, although these are helpful reference documents, none of them are tailored to web3’s unique governance structure and operating model (more on that later).

2. Standardize. There are little to no compensation governance standards within the crypto industry. Organizations are making decisions in a silo because they are isolated from practices conducted at their peers.

   Protocols are grappling over seemingly mundane and administrative issues, such as: who should be evaluating compensation levels and ownership, and how often? What market data do we use? How often should employees receive tokens? What is the most appropriate vesting schedule? etc.

   Web3 organizations do not have human resources professionals in-house to tackle these issues. Leaders are not compensation experts and are thereby forced to rely heavily on prior experience or investors to design compensation plans.

3. Provide transparency. Public corporations are required to disclose pay levels and compensation plan design for their named executive officers. Web3 organizations are not required to report anything compensation-related (yet). Therefore, compensation information is limited to what is electively disclosed on governance forums and Twitter. The Crypto Pay Guide is an attempt to summarize the current state of compensation within the crypto industry. C3 will also leverage our experience working with start-ups and public corporations to provide insight on where we think compensation is headed for this industry.

Why This Matters

Compensation is a key risk area for any organization and the crypto industry should ensure it is taking the appropriate measures to mitigate such risk. Leaders, investors, and communities need to start evaluating employee compensation regularly.

A global pandemic has caused workers to rethink their careers and/or strongly consider remote jobs (i.e., The Great Resignation). Companies are no longer competing for workers locally, which has spawned a tight labor market, specifically for technology jobs given major technology firms now allow remote work and have the resources to raise wages meaningfully. The war for tech talent is fierce and, when combined with an already low supply of web3 natives, results in a tense labor market for the crypto industry.

The loss of developer talent may be the single greatest controllable risk factor that has yet to be addressed. Organizations that fail to regularly evaluate compensation levels for their employees will be at a competitive disadvantage. We have seen DAOs struggle to manage internal issues that may or may not have been caused by a lack of ownership and/or low pay levels. Compensation standards will ensure retention and employee motivation.

For web3 organizations, having an established compensation philosophy and process will avoid criticism from regulators and investors. Regulation is coming – and organizations that have an established compensation process will be ahead of the curve in meeting reporting requirements.

For communities, ensuring organizations follow compensation best practices will create a pay-for-performance model that will drive token value long term. Performance-based compensation has yet to be fully explored and utilized in this industry, which is ironic given the inherent flexibility of tokens.

What to Expect in Future Installments

The Crypto Pay Guide is a series of articles that will be authored and released by C3 over the coming weeks. C3 will dive deep into key compensation topics. We will cover current practices in the crypto industry and provide our insight on where things are likely headed. Future articles will address:

1. Compensation Model

2. Compensation Process

3. Variable Pay Mix / Compensation via Governance

4. Token Granting Best Practices

5. Designing Performance Pay

6. Annual Bonuses (+Coordinape)

7. Stock Options

8. Performance Shares

9. Token Ownership Guidelines

10. Transparency – Market Data and Reporting

And perhaps more…stay tuned!

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C3 is the world’s first Crypto Compensation Consulting group. We advise web3 organizations and communities on compensation levels, incentive design, and governance practices. We have experience advising both large public corporations and small technology start-ups.

Please read more about our firm and services on our website. If you are a leader, investor, or community member who would like to work with us, please contact us at info@c3.email or via Twitter. Follow us to stay up to date on future installments of the Crypto Pay Guide!