How to choose a vesting and lockup schedule for crypto tokens
Successful projects need alignment between founders, core team members, investors, and the project community. Vesting schedules and lockups are one of the most powerful tools available for aligning incentives and long-term value creation.
It takes a village to build a successful protocol. Successful projects need alignment between founders, core team members, investors, and the project community. Vesting schedules and lockups are one of the most powerful tools available for aligning incentives and setting up projects for long-term value creation.
Token vesting is the process where a beneficiary earns tokens based on certain conditions (usually time-based).
At the start of the vesting process, the beneficiary is promised a certain number of tokens, referred to as the token grant. Before vesting conditions are met, the company maintains ownership of the tokens in the token grant. As each condition is met, a portion of the grant is released to the beneficiary. The tokens now in the beneficiary’s ownership are known as vested tokens. When all the vesting conditions are met, the beneficiary gets full ownership over the token grant. This is also known as being “fully vested”.
Because tokens are typically released over time, vesting ensures team members stay committed and work towards the project’s best interests. Vesting is primarily used for founders, team members, and occasionally, investors. Since token grants are often the majority of a beneficiary's compensation, it’s important to understand and design the right vesting mechanism.
There is no perfect vesting mechanism. Each project has unique requirements that feed into their vesting design. Below, we’ll explore the implications of vesting and some example vesting designs.
The period of time in which vesting occurs is known as the vesting schedule or vesting period. A vesting schedule can be as short as you want (e.g., 1-year) and as long as you want (e.g, 10+ years).
Companies prefer longer vesting schedules to retain beneficiaries for as long as possible so the team stays focused on long-term success. On the other hand, vesting beneficiaries prefer shorter vesting periods and greater potential for high earnings.
Both the token grant and vesting schedules are essential pieces to the overall vesting design. Too few tokens or too long of a vesting period can dilute the economic incentives of the beneficiary. But too many tokens or too short of a vesting period can hurt morale or encourage short-sighted behavior.
In fact, some founders have set up 7-10 year vesting schedules that align more closely with company outcome. With longer vesting schedules, founders show their personal commitment to building for the long haul. For team members, we suggest implementing the standard 4-year vesting schedule.
The standard vesting schedule for most token projects (and startups in general) is a 4-year vesting schedule. In this schedule, beneficiaries receive 25% of their token grant each year and become fully vested after 4 years.
Most companies will apply a 1-year vesting cliff to the standard 4-year schedule. A cliff is a period of time in which the beneficiary forfeits their token grant if they leave the project. Additionally, no tokens are vested to the beneficiary during this period. Once the cliff ends, the portion of tokens that would have normally vested in that time are retroactively vested and awarded to the beneficiary.
Cliffs carry several benefits.
A common problem for projects is hiring on co-founders or new team members who don’t fit well into the company culture. Even the best interview processes can fail. Vesting cliffs de-risks hiring by ensuring the project retains ownership of the granted tokens until the end of the cliff.
Some projects will avoid cliffs because team members can often leave a project before their cliff due to personal circumstances. There have also been cases where projects maliciously terminate team members before the end of their cliff to avoid paying out vesting tokens.
Used correctly, cliffs are a great tool to make sure team members are properly aligned with the project and compensated well over the long term.
New 1-year vesting models
Companies like Coinbase, Lyft, and Stripe are experimenting with new vesting schedules. All three introduced a 1-year vesting schedule in mid-2021 to replace their traditional 4-year schedule.
With a 4-year vesting schedule, Coinbase would set up a $200k equity grant to be vested over four years with a 1-year cliff. Now with the 1-year vesting schedule, Coinbase designs $50k annual grants that vest entirely each year. Further, Coinbase eliminates the cliff since the vesting schedule is only one year long.
Pros to 1-year vesting for token projects:
Reduces dilution. If the annual projected growth rate is 25%, a $200k token grant today is worth $360,352 fully vested. However, in a schedule with annual grants of 50k, awarded yearly for four years, the full compensation amount sums up to only $250k fully vested (as seen in the table below). That’s 31% less dilution for the project over those four years.
Eliminates cliff downsides. Since the annual grant is much lower than a 4-year grant, it’s easier for the project to make the decision on a potential candidate. It also makes for a more competitive offer because team members that don’t work out still get to walk away properly compensated for their time.
Happier teams (if token price goes down). 4-year vesting can be quite painful with high price volatility. Team members can get demotivated when they see a substantial portion of their compensation wiped out by a sudden decline in token price. Further, high volatility often yields drastically different compensation outcomes depending on what time an employee joins the team.
Cons to 1-year vesting for token projects:
Lack of long-term upside. Joining a token project is often about realizing the upside of working at a high-growth project. With the 1-year vesting schedule, team members miss out on long-term growth.
Lack of retention and early sell pressure. Because tokens are liquid much earlier than traditional shares, 1-year vesting means team members are more likely to sell tokens once vested, and they might focus on timing the market more than building product.
Benchmark data for token vesting
At Liquifi, we’ve built a suite of tools to simplify token vesting and token cap tables. Data referenced below for benchmarks are sourced directly from publicly available information and from the protocol where available. See our previous analysis for more in-depth data.
On average, we see projects allocate around 30% of tokens towards founders, team members, and investors.
Around 19% of tokens are allocated toward founders, team members, and other contributors.
Around 11% of tokens are allocated toward investors. However, this average includes projects that do not have investors on their token cap table. If including projects with investors, the investor token allocation percentage increases to 19%.
Over 50% of projects employ a 4-year or 3-year vesting schedule for team members. Most projects vesting schedules converge on annual durations. These schedules make it simple for team members to understand their vesting schedules.
While 1-year cliffs are more popular in traditional companies, we see some token projects implement shorter cliffs and, surprisingly, none at all at times. 31% of projects we analyzed have no cliff, and only 38% of projects have a 1-year cliff.
Aptos has implemented a custom vesting schedule, based around the launch date of their mainnet. Vesting only begins once the mainnet is launched, which serves as a particularly strong incentive for the team to reach that goal. Once launched:
There’s a 12-month cliff
From month 13 through 18 after mainnet launch, 3/48ths of the allotted tokens are unlocked
From month 19 through 48 after mainnet launch, 1/48th of the allotted tokens are unlocked so that all tokens are unlocked on the four-year anniversary of the mainnet launch
Creating the right vesting design can have an outsized impact on the success of a project.
Our suggestion is to use the standard 4-year vesting schedule, and occasionally a longer schedule when appropriate. However, something more experimental like the 1-year vesting schedule might be the way to go depending on your project’s liquidity timeline.
For certain team members, like sales or advisors, also consider using milestone-based vesting where the condition to the token grant is a certain milestone. These milestones can include reaching a specific event, hitting engagement or financial KPIs, or closing a strategic customer.
Need to set up your token vesting schedule?
Liquifi automates the entire process of token distribution, handles any type of vesting schedule, and provides tax compliance support.