Blockchain-based ESOP for employees: Where to exchange, Tax rules, benefits – Explained

Newrl, a public blockchain for mainstream decentralised finance (DeFi), recently launched token-based equity solutions for unlisted companies. The blockchain platform claims this to be India’s first first Web3 innovation for ESOPs solution for startups, enabling tokenization of equity to issue ESOPs, raise funds and improve governance through smart contracts. In an email interaction with FE Online, Newrl Founder Swapnil Pawar shared how Blockchain-based ESOP solution for startups would be better for employees. Excerpts: 

How blockchain-based ESOPs help startups and employees? How it is different from the conventional ESOPs? 

Blockchain-based ESOPs have the fundamental essence of security and trust that differentiates it from the conventional ESOPs. ESOPs on smart contracts enables the employees to exercise their rights to vest/sell their shares within the stipulated time frame. There will be no need to go through the lengthy processes and also no fear of the contract not being acknowledged. The smart contracts tend to bind both the parties. 

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The startups can implement higher quality of corporate governance by increasing the trust among their employees and also reputation among investors/shareholders in terms of their ability to keep promises. These processes in return help them to attract better talent as well as reputed investors.

What are the issues related to the ESOPs affecting employees in startups?

Some startups fail to acknowledge its obligations towards their employees in terms of ESOPs, or maybe the terms are so complicated that the employee has difficulty in comprehending the exact timelines with Smart-Contract based ESOPs, the power to take any action for their ESOPs would literally lie on the fingertips of the employees thus making the whole process a lot more easier and fool-proof. Ease of access, terms of the contract and lack of liquidity are the core issues affecting the employees in this space.

How tokenised ESOPs works in real life? And how will these tokens acquire valuation if the startup grows? 

The ESOPs, evaluated based on their underlying values, are converted as tokens via a smart contract. These tokens are then distributed among the employees. Whenever the employee opts to exercise or vest their option on the ESOPs, they would do that without facing any hassle with the help of tokens which represent the underlying shares. Thus, we can say that the value of the tokens would fluctuate at the same rate as per the underlying shares in a simple closed model. We can introduce an open model as well, in that scenario the liquidity of the tokens would affect their prices as well.

Traditionally ESOPs are backed by equities of the companies. These shares go into a SPV, through which smart contracts help in creating   tokens, backed by the equity. These tokens are then distributed to the employees to take action with the help of them. Since these tokens are directly backed by the equities, valuation would directly fluctuate with the market price of the shares/market cap of the firm in the closed system. If we introduce a trading platform for these tokens to be exchanged between employees and other investors as well, it would then affect the prices of these tokens which can deviate from the underlying share prices based on liquidity. 

Where can one exchange or trade these ESOP tokens? Will these attract 30% crypto/virtual digital assets tax?

These ESOPs tokens can be traded on Newrl AMM (Automated market maker) with a liquidity pool. Many startup equity tokens can be pooled together to create this exchange, giving the investors a wide variety of options to invest in. Newrl also has the capability to exchange the tokens with currently popular coins with the help of bridges (connecting to Ethereum, Polygon, etc.). 

Any transaction when being converted to fiat currency would attract 30% digital asset tax as per Indian Government rule. But, if the investors wish to keep their investments in the form of stable coins such as USDC/USDT, they would be free from the digital asset tax for now.

(The views expressed above are those of Newrl Founder Swapnil Pawar and not necessarily of Cryptocurrencies and other virtual digital assets are not regulated in India. Investing in them could lead to losses. Please consult your financial advisor before making any investment decision)