Tokens Are Wet

A more liquid, accessible and decentralized alternative to equity

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Hi! Today’s article is a little different than normal: I (Kristen) generally edit articles but finally decided it was time to write my own! I’m an angel investor at Gambit Investors and have been researching how the equity landscape will change in web3. Below are my findings - hope you enjoy! 🤓

In today’s internet, there is clear incentive misalignment. Users who play the critical role of bootstrapping and sustaining networks are rarely compensated and have little say in product direction or company governance. Furthermore, employees are locked into unfavorable terms for their equity and private investors dominate startup cap tables. 

In web3, tokens are a new primitive that enable founders and organizations to address these fundamentally misaligned incentives. Tokens offer three main advantages over traditional equity for users, employees, and investors:

• They liquidate faster

• They are more accessible: employees don’t have to buy tokens and users can get them in exchange for their contributions

• Tokens are a key ingredient to reaching a more decentralized digital economy and offer more than just economic upside, most importantly distributed voting rights

Tokens are systematically changing the dynamics between stakeholders by pushing power from investors and corporations to builders and contributors. This article will focus on token liquidity with future articles diving deeper into accessibility and decentralization.

Tokens Offer Earlier Liquidity

When investors write a check, one of their primary concerns is the time horizon on which they are likely to make a profit. For this to happen, the company must undergo a liquidity event, defined as

The transfer of an illiquid asset (an investment in a private company) into the most liquid asset – cash.

Let’s take a look at a few traditional web2 exit strategies:

• Listing shares on a public exchange, which can happen through an IPO, Direct Listing, or SPAC merger

• An acquisition

• On secondary markets, private exchanges where investors buy shares from other investors instead of the issuing organization. This Paradigm blog post highlights that this “typically requires company and investor permission, which (surprise) they usually refuse to grant”

On average, it takes close to 10 years for a web2 company to exit

On the other hand, tokens liquidate much faster than traditional equity. As you can see in the timelines below, token launches often occur much earlier in a crypto company’s lifetime than web2 exits historically have.

Note that for any equity investing mechanism that exists in web2, there is a parallel for issuing tokens:

• SAFE = SAFT or Token side letter

• Preferred shares (priced rounds) = Token awards

More to come on these nuances in a future post!

Implications of Faster Liquidity

Founders need new strategies for retaining talent and investors

One group of people that isn’t necessarily excited about faster token liquidity is founders. Over the last few decades, equity in exchange for capital (from investors) and time (from employees) has been a key strategy for founders to ensure long-term buy-in. Said less politely, founders often resort to using equity as “golden handcuffs.”

WeWork is a quintessential example of this: many of the co-working giant’s first employees still worked there as it crashed in 2019 after being paid more than a decade of below-market rates:

One early WeWork employee recalled salaries starting at $36,000 and going up to $60,000 for more senior roles, with the promise of riches by being granted shares in the company.

In web3, some leaders are hesitant to relinquish tokens when they can offer equity. CEO of crypto lending platform Celsius (lol rip) commented on their decision not to give investors tokens:

If you can raise money through equity, you want them as equity investors because they’ll stick with the company for a long time. Sometimes when you give tokens they sell them quickly because it’s like easy money, it’s not like equity

Ultimately, founders will have two options: (1) come to terms with the fact that shorter liquidity lifecycles give them less leverage over capital and labor markets or (2) build companies that people truly want to be involved with, whether that be for the mission, the culture, or something completely novel.

Protections against dumping tokens

With liquidity comes the potential for people to sell lots of tokens in short periods of time. To prevent this, there are mechanisms to reduce the risk of shareholders dumping tokens.

As with equity, founders slowly distribute tokens (to themselves and employees) with vesting schedules. A standard equity vest entails a 4-year vesting schedule with a a 1-year cliff: an employee doesn’t receive the first 25% of options until their first anniversary (the cliff), and every month thereafter gets 1/48 of shares per month (the vest).

Crypto founders are implementing reverse vesting schedules, a structure that offers shorter traditional vesting schedules (typically 2 years) and introduces the idea of a selling schedule. A selling schedule mirrors vesting in that it slowly unlocks the number of tokens one can sell, similar to how vesting slowly unlocks how many tokens one owns. A selling schedule balances the ability for token holders to find some liquidity while limiting the velocity of that liquidation. 

Let’s look at a few potential scenarios of employee vesting schedules to see this in practice:

• Standard equity scenario: vesting 10,000 shares on a 4-year vesting schedule, 1-year cliff. It will take 5 years (60 months) for shares to be liquid.

• Token scenario #1: vesting 10,000 tokens on a 2-year vesting schedule, 6-month cliff. Tokens will start to be liquid after 1 year (12 months).

• Token scenario #2: same as token scenario #1 with the addition of a 2-year selling schedule. Tokens will start to be liquid after 2.5 years (30 months).

Equity is for boomers

As you can see in the far right column, the use of a selling schedule greatly reduces the time an employee can start to realize value from tokens compared to equity (30 months vs. 60 months) while still requiring an employee to commit to more than one year at the business (as is the case in token scenario #1). This is important in maintaining relatively stable token prices (aka minimizing volatility) and ensuring both employees and investors have adequate skin in the game.

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I’d love to chat about your thoughts on the space and where you think it’s headed! Drop a comment below or reach out on Twitter (@kmashiki).

These ideas come from a combination of personal research and learnings from my conversations with web3 founders, investors, fanatics and critics. Thanks to Shekar, Grace, Sridhar, Henri, Daniel, and James for their contributions!

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