Cryptocurrency Compensation: The Next Big Thing?

Over the past year, the alternative and not-yet-fully-evolved area of cryptocurrency compensation has begun trending more mainstream. Several emerging companies have issued compensation to employees in the form of “virtual tokens”.  Is this trend pointing us towards the future of compensation and how does this impact stock plans?

Admittedly, my head is still wrapping itself around the concept of a virtual token. Thankfully, a recent article “Cryptocurrency Compensation: A Primer on Token-Based Awards” by Alfredo B.D. Silva, Ali U. Nardali and Aria Kashefi, published in Bloomberg Law’s Corporate Accountability Report (March 19, 2018) takes a deep dive into this concept and the impact on traditional compensation.

A few things to know about virtual tokens:

• Companies are already using them for non-dilutive capital raising, but also as compensation for employees, directors, and consultants.
• Similar to requirements for stock plans, virtual tokens appear to be subject to securities and tax laws. Both the SEC and IRS have provided guidance on the use of such tokens.
  • The SEC recommends using a test found in SEC v. W.J. Howey Co to determine if issuing virtual tokens is considered an offering of securities. In reading about this more, it seems that in most cases companies should be prepared to consider these tokens as securities and ready to follow the applicable SEC regulations.
  • Similarly, the IRS has also provided guidance along the lines of if the tokens are being issued in exchange for services, then they would be considered compensation and subject to income and payroll taxes.  
• There are now “token based awards” (restricted tokens, token options and restricted token units) which are structured in concept in a manner very similar to traditional equity awards and fall under the same securities, tax and other regulations.
  • There are several considerations around token awards for private companies under Rule 701. I won’t list them all here, as the article covers these in great detail.
• In certain cases, additional disclosures to token recipients may need to be made.
• Don’t forget to consider state laws.

Silva et al caution private companies against running out and swapping out current stock plan language to allow for issuance of tokens. “While issuers may be tempted to draft token incentive plans by simply replacing ‘‘stock’’ with ‘‘token’’ in precedential equity incentive plans, care should be taken in drafting a token incentive plan — for example, provisions related to lock-ups, changes in control, recapitalizations and post-settlement transfer restrictions either do not apply or have to be significantly altered for application in the context of tokens.”

Will token plans replace equity plans? Silva et al explain that “Whereas the market for compensatory equity is well understood, compensatory token-based awards raise new questions for issuers to answer: Should the issuer offer both equity and token incentive awards? What percentage of tokens to be generated should be reserved for awards to service providers? Should token-based awards be allocated among service providers in the same proportions as traditional equity-based awards?” These are all questions with emerging, but not fully flushed answers. There are some obvious benefits to token awards, including that they are non-dilutive. I can’t see token awards outright replacing equity awards anytime soon, but they certainly seem to be finding their way into at least a portion of the compensation pie at some emerging companies.

This trend appears to have longer term traction potential and this is something to keep on the radar.  The entire article referenced in this blog is available on our website for NASPP members and is worth a read for those who are seeking a lay-of-the-land primer on this topic. Those seeking additional information beyond the article may be interested in a recent CompensationStandards.com webcast “How to Use Cryptocurrency as Compensation” (February 12, 2019 - available to their members).  That webcast features three panelists, two of whom were authors of the above mentioned article.

-Jennifer