Cryptocurrency Vesting Explained

What is cryptocurrency vesting?

The process of locking up cryptocurrency tokens or coins for a predetermined amount of time before allowing the token holder to fully access or transfer them is called cryptocurrency vesting.

They are commonly used for initial coin offerings (ICOs), token sales, and other cryptocurrency-related fundraising activities. Cryptocurrency vesting aims to encourage long-term commitment and prevent early investors or team members from rushing to sell their tokens for a profit and then leaving the business. The person or entity obtaining the tokens gains access to the tokens gradually over time, usually at predetermined intervals, by imposing a vesting period.

Vesting schedules can vary, but typically consist of a waiting period (also known as a cliff) and periodic release periods. For example, tokens could have a cliff of one year and be offered in equal monthly payments thereafter.

Vesting is often applied in the following cases:

• Team and Advisors: To ensure continued commitment to the project by team members and advisors, tokens provided to project developers may be subject to vesting.
• Investors: Early investors in an ICO or token sale may be subject to a vesting period to prevent short-term speculation.
• Founders: To align their interests with the long-term performance of the project, project founders or core team members can hold their own tokens.

Smart contracts on blockchains are commonly used to implement vesting, ensuring that regulations are clear and applied automatically. This mechanism helps build trust between the community and investors because it demonstrates the commitment of key stakeholders to the success of the project in the long term.

Typically, tokens are unlocked through a variety of methods following a vesting period. During this process, tokens that have been locked for a certain period of time are released. Token holders gain progressive access to their assets over time due to these unlocks, which often occur in stages or increments. Release conditions may include meeting milestones, achieving time-based schedules, or performance indicators.

Cryptocurrency Vesting Types

The different types of vesting in the cryptocurrency space include time-based, milestone-based, hybrid, and reverse vesting.

Time-based vesting

With time-based vesting, tokens are released to holders progressively over a set amount of time. For example, Ethereum implemented a time-based vesting system for early backers. Multiple publicly accessible smart contracts enable progressive vesting of ERC-20 tokens, such as those allocated to founders in crowdsales. Nonetheless, there is no equivalent way to vest “raw” Ether (ETH) as distinct from wrapped Ether.

Raw Ether refers to the native cryptocurrency on the Ethereum blockchain, usually in an unmodified state. Unlike Ethereum representations on other blockchains, such as wrapped Ether on the Ethereum network or ERC-20 tokens representing Ether on other networks, it is not tokenized or wrapped. This native Ethereum is not compatible with some of the features or smart contracts tailored to tokens, and requires specific mechanisms for vesting that are not as readily available as tokenized assets.

Milestone-based vesting

With milestone-based vesting, token distribution is contingent on achieving specific project goals or benchmarks. Some blockchain projects may implement an attribution system based on milestones of partners and team members.

For example, a percentage of allocated tokens may be distributed based on successful implementation of a specific feature, successful completion of a protocol update, or other notable project milestones.

Hybrid Vesting

Hybrid vesting combines elements of both time-based and milestone-based vesting. Blockchain projects often use a mixed vesting model for token allocation. Token segments allocated to teams and early backers follow a time-based vesting plan and are unlocked gradually over a set period of time.

At the same time, another part is linked to the achievement of predetermined milestones of the project. This dual approach ensures alignment with project goals and recognizes long-term commitment and success milestones.

reverse vesting

According to the concept of “reverse vesting,” tokens initially owned by the recipient may be forfeited if certain requirements are not met. This is the opposite of regular vesting. Filecoin used reverse vesting for Simple Agreement for Future Tokens (SAFT) users.

Mining rewards are distributed according to a schedule that promotes long-term network alignment. 25% of block rewards are released immediately to improve miner cash flow, while 75% of block rewards are granted progressively over 180 days. The Protocol Labs team and the Filecoin Foundation will receive additional Filecoin (FIL) tokens over six years, while SAFT investors will receive tokens over three years.

Comparison of cryptocurrency vesting and traditional financial vesting models

Cryptocurrency vesting leverages blockchain technology for transparency and automation, while traditional financial vesting relies on centralized management to achieve similar goals within a traditional corporate framework.

Cryptocurrency vesting models share similarities with traditional financial vesting models, but exhibit distinct characteristics due to the unique characteristics of blockchain-based assets. In the cryptocurrency world, vesting is typically performed through blockchain-based smart contracts that provide automated and transparent enforcement of vesting rules.

Aligning the interests of token holders – investors, advisors and project teams – with the long-term growth and success of a project is the primary goal of cryptocurrency vesting. In traditional finance, stock-based compensation plans such as stock options and restricted stock units (RSUs) are often associated with vesting.

Traditional vesting methods are typically managed through centralized systems in corporations and financial institutions, unlike crypto vesting which often uses smart contracts on decentralized platforms.

Time-based vesting in traditional finance typically involves a waiting period before management or employees fully own the shares they have been granted. By tying a portion of an employee’s salary to their continued employment, you can increase employee retention and loyalty. Milestone-based vesting is less common in traditional finance, but can occur in some performance-based equity programs where shares are released only after predefined business objectives are achieved.

How does token vesting affect token supply?

Token vesting governs the gradual distribution of tokens, influencing available supply and market dynamics.

By controlling the supply of tokens available in the market over time, token vesting directly affects the circulating token supply. Vesting-related tokens are generally not immediately tradable or tradable.

This causes these tokens to not be considered part of the available supply until they are fully vested. During the vesting period, circulating supply decreases, which affects metrics such as market capitalization and available liquidity.

Tokens enter circulating supply when they are progressively unlocked or granted according to pre-established schedules or conditions. This can impact market dynamics, investor sentiment, and the supply-demand balance in the ecosystem.

Benefits of Cryptocurrency Vesting

Cryptocurrency vesting based on smart contracts increases investor confidence by ensuring transparent, flexible and secure coordination of stakeholder interests and long-term project success.

Cryptocurrency vesting offers several benefits in the blockchain space. The use of smart contracts in decentralized networks ensures that vesting requirements are transparent and automatically enforced, building trust among token holders.

The interests of the team, advisors and investors are aligned with the long-term success of the project through time-based and milestone-based vesting mechanisms. Because cryptocurrency vesting is flexible, projects can tailor the system to meet their unique needs, which encourages accountability and commitment.

Additionally, utilizing blockchain technology makes the process more secure as it is immune to centralized manipulation and tampering. All things considered, cryptocurrency vesting is essential to foster long-term project development, reduce speculative activity, and increase investor confidence.

Risks and Challenges Associated with Cryptocurrency Vesting

Regulatory uncertainty, smart contract vulnerabilities, liquidity risk, lack of standardization, and incentive balancing make cryptocurrency vesting less efficient.

Cryptocurrency vesting provides the necessary incentives, but it also carries risks and challenges. Legal issues may arise due to regulatory uncertainty in the development of the cryptocurrency ecosystem, which may affect the enforcement of attribution agreements.

Token holdings may be compromised due to smart contract flaws and code mistakes that result in unexpected results or security breaches. Once unlocked, the liquidity risk attached to vested tokens may result in sudden market fluctuations or even sell-offs.

Additionally, investors may be confused if vesting procedures are not the same across projects. Finding the ideal balance between recognizing commitment and ensuring project success is a constant struggle. Overall, properly negotiating the complexities of cryptocurrency vesting requires careful consideration of legal, technical, and market-related issues.