The crypto world in recent years has been adapting and evolving in the face of increasing governmental scrutiny and regulation. As this trend continues, more actors and participants in the crypto space are looking for more legal stability and certainty in what they do. As an HR and legal matter, the preferred approach in crypto compensation and benefits has been to use traditional compensation plans and rewards as a starting point and benchmark. This is why you might have heard about companies exploring token-based awards like restricted token units (RTUs).
Companies, especially those working in the crypto space, have been rethinking how they can do compensation and benefits differently. Crypto compensation is a subject that’s not talked about enough. This is understandable, as there are legitimate concerns about the volatility and risks inherent in virtual currencies and digital assets. Your HR and legal department are usually risk-averse and don’t want to deal with matters that come with a lot of asterisks and uncertainty.
If you want to know more about how it works, we have got you covered. Here are the answers to some of your most common questions about RTUs and token-based awards.
In essence, RTUs represent a company’s promise to pay a worker or employee blockchain-based coins or tokens once certain vesting conditions are met.
RTUs are like restricted stock units (RSUs). But instead of stocks, what‘s awarded are tokens instead.
Ideal RTU users are companies working on a crypto token project or anything that has a token component. This will allow the company to use its tokens as additional incentives to its employees and developers without having to issue stock and worry about share dilution. However, it’s also possible for traditional or brick-and-mortar companies to use RTUs if they are planning to launch a token project of their own.
It’s important for the RTU plan to be drafted carefully to ensure that all potential tax issues and legal risks are minimized as much as possible.
Each RTU represents a token that the company is contractually obligated to pay out once the vesting condition for the token award agreement is met. The condition can be anything, but the more common ones are time-based such as the employee staying with the company for a given number of months or years. The condition can also be based on an employee’s performance or a mix of both.
For example, an RTU plan might grant 10,000 RTUs to an employee which will fully vest on his 6th year with the company. When the employee reaches his 6th year with the company, he/she is legally entitled to demand the settlement of RTUs into tokens.
Alternatively, the RTU plan could also provide that 50% of the tokens will vest in the employee's 1st year (called a “cliff”) while the rest of the RTUs would vest at a uniform rate of 10% of the total amount for the next 5 years. As you might observe, there are lots of unique and creative ways to customize an RTU plan to fit a company’s needs.
This is particularly good for companies that are still building out their product and want to stabilize the value of their coin or token. Currently, crypto projects are doing something similar by locking tokens in smart contracts for set periods of time or until certain conditions are met. RTUs fulfill the same function as deferred compensation plans which is something that regulators are more familiar with.
For blockchain companies, RTUs provide the needed legitimacy in the eyes of not only employees but also of regulators who are familiar with the RSU framework. Chances are, if they encounter RTUs, they will analyze and treat them the same way as RSUs. Hence, blockchain companies have an established legal framework that they can rely on for their token plans.
Unlike shares of stock granted under an equity compensation plan, tokens don’t dilute the ownership interests of other shareholders. Token holders also don’t have voting rights.
This means that crypto companies issuing tokens can still take advantage of the motivating and aligning powers of equity rewards without needing to actually issue equity. This is an option and flexibility that other companies don’t normally have.
Like RSUs, there are also token-based counterparts for stock options called token options. Stock options are subject to the requirements of Section 409A of the Internal Revenue Code which can make things a bit more complicated.
Right now, it is still unclear if the requirements of Section 409A actually apply to tokens and token options, but it is safest to assume that they do. Therefore, it’s best not to risk using token options and then be exposed to all issues related to Section 409A.
The IRS in its Notice 2014–21 has made a determination that tokens are to be treated as property for tax purposes. In other words, the tax base for tokens is its fair market value. This can be problematic if the token is awarded to an employee when its market value is at an all-time high as this means that the employee will have to pay a significant amount of taxes just so they can receive the tokens.
RTUs can be customized in such a way that their issuance is deferred until a liquidity event happens. Once the liquidity event occurs, they are able to easily convert them into fiat currency and pay the necessary taxes. If tokens are issued without safeguards like this in place, employees will be subjected to a hefty tax bill that they might not be able to pay because of a lack of cash.
Compared to token options, employees awarded with RTUs don’t have to put up any amount to be able to claim their token rewards. If the value of the underlying token falls significantly and goes under the exercise price of the token option, the employees lose money. With RTUs, the employee is always guaranteed to receive something so long as the token is also worth something.
In other words, there is no risk for the employee to lose any money as they do not need to pay anything to the company in order to receive the token award.
It’s ideal to have a written agreement. For one thing, it’s better to have a written plan in place instead of relying on a handshake agreement. For another, an RTU plan is a great hedge against the risk that your tokens will be characterized as securities by the SEC.
To avoid being subjected to enforcement action for issuing securities without registration to employees, an RTU plan can serve to satisfy the “written compensatory benefit plan” requirement under Rule 701 of the 1934 Securities Act.
But having an RTU plan alone is not sufficient to effectively mitigate this risk. You must ensure that your RTU plan is compliant with all the other conditions and requirements of Rule 701.
Some companies might have smart contracts in place to govern some aspects of their token issuances to employees. The problem with this, however, is that smart contracts can be inflexible. They can also be prone to major bugs and exploits like the one from the staking protocol called Compound which led to about $162 million in losses.
RTUs can provide additional legal protection that can be enforceable in courts of law in case something goes wrong with the smart contract. They are also more flexible as they can be designed to be subject to less stringent requirements for amendments.
Preparing, implementing, and managing your own token reward plan can be costly and messy. With all the uncertainty and risks surrounding tokens and cryptocurrency, ensuring that your token reward plan is sound and legally compliant is very important.
With Uptoken, we take care of that for you. Our RTU plans have been vetted and scrutinized by experts and lawyers and come with customizable features and provisions to allow some flexibility. Uptoken RTUs also come with international support and works in 70+ countries around the world. If you want to know more, we’re here to talk.
Upstock or Uptoken does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for such tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.