Like traditional startups, most new crypto projects rely on investors in order to acquire operating capital. Investors who buy into a project are awarded with a specific number of crypto tokens proportional to the size of their investment.
The value of those tokens varies with time and depends upon a number of factors, including supply and demand. If early investors were to suddenly flood the market by selling all of their tokens, the project's future success would be in jeopardy because token values would suddenly plummet. To keep that from happening, many new projects establish a crypto vesting program.
What Is Vesting?
Vesting is a process whereby certain assets that have been set aside are released, and can be acquired only when a defined set of criteria has been satisfied.
The vesting process isn’t unique to the crypto market. In fact, it’s been around in the traditional finance world for decades. When defined benefit packages were still popular, such as pensions and other retirement plans, those benefits were only awarded when an employee reached a certain age or had been employed by the company for a predetermined amount of time. At that point, the employee had become vested.
Vesting has also been used to award stocks and stock options to CEOs and other senior management in publicly traded companies. In today's crypto market, tokens represent the assets to be set aside for later acquisition by team members. The amount of time required for an employee, investor or other team member to become vested is known as the vesting period.
How Does Vesting Work?
The process of vesting typically begins with setting aside certain assets that are reserved for the vesting process. These might consist of crypto tokens, stocks, stock options, pensions or other assets. For instance, an employee might become vested in the company's pension plan after 10 years of successful employment.
Another example would be if a company's CEO is eligible for stock options after two years, provided that the company has seen an increase in sales of at least 20 percent during that time period. In the crypto world, vesting might mean setting aside 25 percent of a project’s tokens, and allowing team members to acquire them in stages over a four-year vesting period.
Types of Vesting Schedules
A vesting schedule determines the amount of time that team members must wait before they become partially or fully vested. The schedule works by allowing team members to acquire a portion of the set-aside assets in phases, until they reach a point where they’ve acquired all of the assets to which they’re entitled. At that point, they are said to be fully vested.
The three basic types of vesting schedules are linear vesting, graded vesting and cliff vesting.
Linear vesting means making assets available in a linear (or straight-line) amount and time period. In other words, the amounts and time periods are always equal. For example, qualified participants may be eligible to acquire 5 percent of the vesting assets every six months, so that they acquire a total of 20 percent after two years. Linear vesting is often combined with cliff vesting.
Graded vesting is the exact opposite of linear vesting. It lets participants acquire different amounts of assets over different time periods. For example, a graded vesting program might allow 5 percent acquisition after the first six months of employment, another 10 percent at the end of 18 months, and an additional 15 percent at the end of three years, for a total asset value of 30 percent. If a team member were to leave employment for an unapproved reason during the vesting period, they would only receive the amount of assets that they had acquired at the time.
Cliff vesting, as its name implies, invokes a sharp change — as if a person were falling off a cliff. It can be used to specify when a vesting program begins, or when a person becomes fully vested. For example, a cliff vesting program might begin after six months of successful employment. If an employee resigns or is let go before completing their first six months, they aren’t vested, and have no ownership of the assets in the vesting program. Following successful completion of the cliff time limits, the vesting program could continue along the lines of linear or graded vesting.
Benefits of Token Vesting
Crypto vesting is becoming the norm, with longer vesting periods. Several types of vesting programs are in use with different vesting schedules. It’s up to each project to determine the type of vesting program, the number of tokens that will be set aside, the vesting period and the vesting payout schedule that works best for their project.
Advantages of a crypto vesting program include better team member loyalty, protection of investment capital, and a reduction in market manipulation by unscrupulous and fraudulent investors.
Prevents Premature Selling
One benefit of token vesting is that it prevents startup founders, first round investors and initial developers from prematurely selling their shares, which could flood the crypto market and lower the value of the tokens.
When tokens are securely locked in a vesting program, they’re more likely to retain their value — or even increase in value if the company is viewed as successful. This also provides assurance to early investors that their crypto investment is safe, and is likely to grow in value.
Creates a Sense of Loyalty
Another benefit of vesting is that it helps to create a sense of loyalty and dedication from team members, who know that they’ll be rewarded for their hard work and diligence at a future date. This way, they’re more likely to act as stakeholders and to do what they can to make the company successful. Not only will team members be eligible to receive tokens at a later date, but those tokens are more likely to increase in value if team members actively contribute to the company's success.
A third benefit of token vesting is that it helps to prevent scams and fraud. Vesting discourages people from buying a company’s tokens for the sole purpose of dumping them as soon as the price hits an early high.
This type of fraudulent activity — along with larger, more organized scams, such as pump-and-dumps — can leave a company strapped for cash and, in some instances, unable to survive. Fraudulent investors won’t find it appealing to have their money locked for an extended period of time while they’re waiting to become vested.