If you tear a bank note into two and hand the other half to someone else, you have a transaction.  Each half validates the other, and the whole banknote represents a promise to pay a specified sum.  Nobody has any value until those two halves come back together again.

Bitcoin is like that, but what Satoshi Nakamoto started on the 3^rd January 2009 when he mined the genesis block will eventually transform the way we all conduct transactions. This is not just for nerds, so please read on, especially if you are interested in how this relates to remuneration in this emerging sector.

It is true that bitcoin can be mined out of thin air but there is a protocol (a peer-to-peer network) and a public transaction ledger (‘the blockchain’) which limits the total bitcoin in the world to just under 21 million in number. Most have already been created – the final coin will be “mined” by around the year 2140, according to estimates.

Not surprisingly, work in the area of remuneration and incentive design has grown at a rapid rate. The purpose of this article is to look at the implications for the digital world of incentive compensation design: how do you design rewards in this rapidly emerging world?

It is a question of enormous importance because just as we once had a world filled with small merchant banks that each had a role in the financial world, and then they merged into the financial machine we call ‘Wall Street or The City’, so we now have a rapidly flowering world of crypto ‘players’ – companies that offer much that used to be thought of as ‘banking’, but in a digitally transformed way. These companies, just as in the City or Wall Street, are struggling to manage the resources they need: their talented, footloose, constantly disruptive, creative workforce. The winners will digest the losers, and so we have a race on our hands.

Comparing Old Fashioned Incentives with their Crypto Equivalents:

Shareholders of large financial institutions in the 80s and 90s would have felt very much like the shareholders of companies in this new digital business world. The opportunity for cross-fertilisation of creative ideas is dazzling, it’s just that – for those less familiar with some of the technology – the story may be the same, but it is just happening incredibly fast.

For example, over the last four years a bitcoin’s value rose from $10,000 to a high of nearly $65,000 then fell back to $19,164[1] very recently. The challenge for those responsible for finding and keeping talent is to create an incentive structure that aligns individuals with their business priorities, as well as the strategy of investors seeking shareholder value creation.

Let’s consider how an old-fashioned financial services company with investment banking, asset management and wealth management divisions would incentivise their people, and why, and then compare that to the new digital world.

Investment banking: the goal is to create value through transactions, deal management, funding tactics. This division hires people who are experienced in a range of business situations and who have a wide range of skills: accounting, finance, strategy, comfort around ‘owners’.

Success is measured in fees, and spreads over lending.

Incentives are largely designed with the following in mind:

• Higher salaries for more experienced ‘talent’ – these are ‘stars’ who attract clients
• Significant variable cash-based, short-term compensation – this is a cyclical business and it is expected that bonus pay-outs will ebb and flow with the economic tides
• Limited participation in long-term incentives, which are used to retain key individuals – far more weight is placed upon short-term cash (even deferred cash) pay

Although there are companies operating in the crypto market in similar ways to, let’s say, traditional Venture Capital (cataloguing good projects, investing early), the difference is the level of maturity. In the digital world, there is a need to “move fast and break things” such that risks are higher. If we look at the typical funding cycle [pre-seed, seed, then Series A, B, C] where pre-seed is often barely an idea with funds raised from close friends, seed is testing viability with the barest initial competitor analysis and the beginnings of pitch decks and series A is where the product is validated, growing but ‘early stage’, crypto projects often never make it past the first two rounds. Very few reach maturity, and few companies have fully validated business models.

What also makes investing in Crypto Businesses – and specifically crypto-currencies – different is that they often raise money through issuing new crypto-assets or tokens rather than via sale of equity. The offer of Tokens for the earliest investors means early cash out and exceptional returns when it goes well, but such ‘token sales’ and ICO’s (Initial Coin Offerings’) often do not ‘go well’.

So, incentives are largely going to be designed for crypto business in the same way as our ‘old-fashioned-financial services firm’, but with these differences:

• There may be the promise of higher salaries for more experienced ‘talent’, but cash is often in very short supply, so base pay is kept at lowest levels possible
• In the end variable rewards have to be very short-term in nature and cash-based
• There is significant scepticism about participation in long-term incentives

For those who might be regarded as ‘Founders’ (a term that is used far more widely in crypto than in almost any other sector, financial or otherwise) rewards may be in ‘native coin’[2], sometimes with vesting schedules attached. While it would appear to be the obvious ‘alignment’ of management with stakeholders, the realities are problematic. To begin with, the release of vested tranches onto the open market creates market volatility. But the main issue is that expending huge effort on a complex project may only leave you with a worthless bag of tokens if a market slump coincides with vesting. No wonder there is resistance to the concept of long term incentivisation!

Conclusion

In the same way that the relatively slow-moving, under-invested, union-dominated, grim ‘70s gave way to an investment banking ‘Big Bang’ in the City of London during the 80s, we are under-going a profound digital transformation today. The laptop-focused executive working from a home office, receiving home food deliveries, conducting business over video links and tearing up that precious airline ‘gold card’ is not going away. It is a permanent change, and it brings both good and bad. Less contact with colleagues, but more free time. Lower costs of shopping, lower emissions, but new suppliers expecting a minimum of digital capability.

Digital currency, and digital transactions are part of this shift. It may be volatile, but it is permanent.

The power of incentives in any business is a fact of life.  People do what they are paid to achieve, so it makes sense to line up incentives towards a few goals that make the difference. Rather as traditional car manufacturers can make e-cars, traditional incentives can be adapted in the same way.

To read the full article from Remuneration Associates, click here

[1] As of 18/10/22

[2] Every independent blockchain has its own native crypto; e.g. Bitcoin is BTC; Ethereum is ETH; Dogecoin is DOGE, etc

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