Vesting in crypto, explained

What is crypto vesting?

The process of locking down cryptocurrency tokens or coins for a predetermined amount of time before allowing the tokenholder to fully access or transfer them is known as crypto vesting.

It is commonly used in initial coin offerings (ICOs), token sales and other cryptocurrency-related fundraising activities. Crypto vesting aims to incentivize long-term dedication and deter early investors or team members from hastily selling their tokens for a profit and then leaving the business. Individuals or entities that get tokens gradually gain access to them over time, usually at predetermined intervals, by imposing a vesting period.

While vesting schedules are subject to change, they usually consist of a waiting period (known as the cliff) followed by regular periods of release. Tokens may, for instance, have a one-year cliff and then be made available in equal monthly payments after that.

Vesting is frequently applied to:

• Team and advisers: To ensure the team members’ and advisers’ continued dedication to the project, tokens given to project developers may be subject to vesting.
• Investors: Early investors in an ICO or token sale may also be subject to vesting periods to deter short-term speculation.
• Founders: To match their interests with the project’s long-term performance, a project’s founders or core team members may have their tokens vested.

Smart contracts on the blockchain are usually used to implement vesting, ensuring that the regulations are clear and automatically applied. This mechanism helps build trust among the community and investors, as it shows a commitment from key stakeholders to the project’s success in the long term.

Typically, tokens are unlocked via various methods following their vesting period. In this process, tokens previously locked for a predetermined period are released. Tokenholders can progressively access their assets over time due to this unlocking, which frequently happens in stages or increments. Release conditions could include meeting milestones, a time-based schedule or achieving performance metrics.

Types of vesting in crypto

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

Time-based vesting

With time-based vesting, tokens are progressively released to holders over a set amount of time. For instance, Ethereum implemented a time-based vesting system for its early backers. Multiple publicly accessible smart contracts enable the gradual vesting of ERC-20 tokens, such as those allocated to founders in a crowdsale. Nonetheless, there isn’t an equivalent method for vesting “raw” Ether (ETH), which is distinct from wrapped Ether.

Raw Ether typically refers to the native cryptocurrency on the Ethereum blockchain in its unaltered state. Unlike representations of Ethereum 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 original Ethereum isn’t compatible with some functionalities or smart contracts tailored for tokens and requires specific mechanisms for vesting, which aren’t as readily available as for tokenized assets.

Milestone-based vesting

With milestone-based vesting, token distribution is contingent upon accomplishing particular project objectives or benchmarks. Some blockchain projects may implement a vesting system contingent on milestones for their partners and team members. 

For example, a percentage of the allotted tokens may be distributed upon the successful implementation of a particular feature, the successful conclusion of a protocol update or other noteworthy project milestones.

Hybrid vesting

Hybrid vesting combines elements of both time-based and milestone-based vesting. Blockchain projects often employ a mixed vesting model for token allocation. A segment of tokens assigned to the team and initial supporters follows a time-based vesting plan, unlocking gradually over a set duration. 

Concurrently, another segment is tied to the project’s achievement of predetermined milestones. This dual approach ensures harmony with project objectives and recognizes long-term commitment and success milestones.

Reverse vesting

Under the notion of “reverse vesting,” tokens that a recipient initially owns may be forfeited if specific requirements are not fulfilled — the opposite of typical vesting. Filecoin used reverse vesting for its 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, and 75% of block rewards vest gradually over 180 days. Protocol Labs teams and the Filecoin Foundation will receive additional Filecoin (FIL) tokens over six years, while SAFT investors will receive their tokens over three years.

Crypto vesting vs. traditional financial vesting models

While crypto vesting leverages blockchain technology for transparency and automation, traditional financial vesting relies on centralized administration to achieve similar goals within the traditional corporate framework.

Cryptocurrency vesting models share similarities with traditional financial vesting models but also exhibit distinct features due to the unique nature of blockchain-based assets. In the cryptocurrency world, vesting is typically accomplished via blockchain-based smart contracts that provide automated and transparent vesting rule enforcement. 

Aligning the interests of tokenholders — such as investors, advisers and project teams — with the project’s long-term growth and success is the main objective of crypto vesting. In traditional finance, equity-based compensation plans, such as stock options and restricted stock units (RSUs), are frequently associated with vesting. 

Traditional vesting methods are typically managed through centralized systems by businesses and financial institutions, in contrast to crypto vesting, which frequently makes use of smart contracts on decentralized platforms.

Time-based vesting in traditional finance usually entails a waiting period before executives or workers fully own the shares they have been awarded. By associating a portion of an employee’s pay with their continuous employment, this promotes employee retention and loyalty. Although milestone-based vesting is less typical in traditional finance, it can happen in some performance-based stock programs where shares are released only after predefined business goals are met.

How does token vesting impact the token supply?

Token vesting manages the gradual release of tokens into circulation, impacting the available supply and market dynamics.

By controlling the supply of tokens available in the market over time, token vesting directly impacts the circulating token supply. Tokens that are vesting-related are usually not immediately available for trading or circulation. 

Because of this, until these tokens are fully vested, they are not regarded as part of the available supply. The circulating supply is reduced during the vesting period, which affects metrics like market capitalization and available liquidity. 

Tokens enter the circulating supply when they progressively unlock or vest by preset schedules or conditions. This can impact market dynamics, investor sentiment and the ecosystem’s supply-demand balance.

Benefits of crypto vesting

Crypto vesting, powered by smart contracts, ensures transparent, flexible and secure alignment of stakeholder interests with long-term project success, fostering investor confidence.

Crypto vesting offers several benefits in the blockchain space. By using smart contracts in decentralized networks, vesting requirements may be enforced transparently and automatically, which builds trust among tokenholders. 

The interests of teams, advisers and investors are aligned with the long-term success of the project through time-based and milestone-based vesting mechanisms. Because crypto vesting is flexible, projects can customize systems to meet their unique requirements, which encourages accountability and dedication. 

Furthermore, utilizing blockchain technology makes the process more secure by being impervious to centralized manipulation and tampering. All things considered, crypto vesting is essential for fostering long-term project development, reducing speculative activity and fostering investor confidence.

Risks and challenges associated with crypto vesting

Regulatory uncertainties, smart contract vulnerabilities, liquidity risks, lack of standardization and balancing incentives pose challenges to the effectiveness of crypto vesting.

Crypto vesting offers necessary incentives, but it also poses risks and difficulties. Legal concerns may arise from regulatory uncertainties in the developing cryptocurrency ecosystem that may affect the enforcement of vesting contracts. 

Token holdings could be compromised by smart contract flaws and code mistakes that result in unexpected outcomes or security breaches. Once unlocked, the liquidity risk attached to vested tokens may cause abrupt market swings or even sell-offs. 

Furthermore, investors may become confused if vesting procedures are not uniform among projects. Finding the ideal balance between acknowledging dedication and ensuring project success is a constant struggle. Overall, properly negotiating the complexity of crypto vesting requires careful consideration of legal, technological and market-related concerns.