On Token Vesting
Token vesting in Web3 controls token release to prevent mass sell-offs, protecting price stability. Learn what it is, how it works, and why strategies like randomized vesting could improve market health and protocol governance.
Original author: Jagrut Kosti, R&D Team Lead
Token vesting is one of the less talked about topics in Web3. And probably it's for the best! Let's explore, what it is, why it can be useful and if it is actually solving any problem.
What is token vesting and how it works
Token vesting refers to a certain percentage of tokens that you know for sure will be available for use and trade. It's similar to ESOPs (Employee Stock Option Plans) with a major difference that ESOPs, even when vested, cannot be freely traded right away.
There are a lot of nuances on the structure of token allocation and what vesting exactly means. This changes from project to project. For example, a project can make only 20% of the total supply of tokens available for claiming/air drop. The rest can either be allocated later in further rounds of allocation, or they are part of the token emissions via staking rewards, etc.
Why web3 projects use token vesting
Most Web3 projects deploy vesting strategies to prevent mass dumping of their token after the initial allocation or air drop, and therefore saving the token price from plummeting. The rationale is that since there are more tokens to be vested (unlocked), no one can dump all of their tokens and exit. Which leaves room for speculation whether the future vested tokens will be dumped or not, preventing the token price from completely nose diving.
Broadly speaking, there are generally 2 different types of vesting strategies:
- Only a certain percentage of total supply is in circulation and distributed via air drops. The unvested (locked) tokens are then brought into circulation via protocol metrics like validator rewards, emissions, etc. The unvested tokens are NOT air dropped again to the same set or a large subset.
- Similar to the first one, but unvested tokens are brought into circulation via more air drops and the new vested tokens are distributed to the same set or large subset.
Next section is only applicable to the second type.
Is it effective?
I'll try to explain why vesting is actually worse than fully unlocked/vested tokens at the time of launch. Here are some assumptions we have:
- This analysis is from a token holder's / air drop recipient's perspective only. Does not include token buying or investors.
- The token holder knows about all their vested tokens and their schedule.
- The vesting schedule is fixed for all token holders i.e. the tokens are vested at the same time for all token holders.
From a game theory view, any airdrop is a positive-sum game. This means there is no money lost even if the token price drops to zero. The utility is to derive the maximum profits. Many token launches use staged vesting schedules, where a portion is released at launch and the remainder in periodic instalments. For example, a project could release 20% at launch and then 20% quarterly, fully vesting by year-end.
Game theory analysis of token vesting
Every user (U) is playing a game with the market (M). Each of them can either Sell (S) or Hold (H). Based on how useful the tokens are and the idea that more tokens will come later, the following utility matrix shows the result.
| M \ U | S | H |
|---|---|---|
S | (1,1) | (1, -3) |
H | (0,2) | (0,0) |
A user's action affects the market less than the market affects the user. If both U and M sell at the airdrop, they each get utility (1,1). If U holds and M sells, the user suffers more, so utility is (1, -3). If U sells and M holds, the user gains slightly more, with utility (0,2) or (0,1). Holding gives both a utility of 0. Game Theory shows a pure-strategy Nash Equilibrium here: each player's best choice is to sell, ensuring a payoff of (1,1).
This matrix is only valid when User knows that there are more tokens that will be available in the future. All assets can gain value over time. It is best to keep some tokens because there is a chance the protocol will succeed. The last vesting schedule is the same as protocols without a vesting schedule. It lets the user decide based on how they think the protocol will do. Which implies that all the vesting prior to the final one, simply gives more chance for users to dump their token.
From the protocol's perspective, this is disastrous. The token price shows what the market thinks about the protocol's success. The protocol will get a bad reputation even if it is technically good. Airdrops without vesting schedules let the market decide how to value the protocol. The market sets the best price.
Token distribution and vesting impact on holders
Most protocols give most of their tokens to investors, the core team, and early users. For example, Liquifi Finance benchmarks show roughly 18.8% allocated to founders/employees and 13–17% to investors. Protocols like Uniswap have explicitly distributed their governance tokens to early users, investors, the team, and community treasury. For these teams, vesting or no-vesting should not make a difference and they would ideally Hold till the protocol gains some traction.
Vesting still gives some people too much power to start selling at the most advantageous time. This is especially true for investors, whose main goal is to make profits over time. Don't get me wrong, I'm not trying to throw negative light on investors, I'm simply talking about their utility from a rational perspective.
No matter how the newly vested tokens are shared, the new circulating supply lowers the Fully Diluted Valuation (FDV). It also increases the pressure to sell.
Randomized vesting schedules to stabilize token markets
Yes! A trivial sounding but not-so-trivial to implement on chains, is the idea of randomized vesting schedule. For each user, when the tokens will be vested is randomized. This creates a situation where a market cannot act in one way at one time because there is a fluctuating volume of tokens being vested every now and then.
For trading, randomized vesting schedules work to avoid nose diving token prices. For governance, certain things need to be taken care of. Since tokens do not all vest at the same time, the voting process should count all tokens. This includes tokens that are not yet vested if the protocol uses one-token-one-vote.
So how can randomized vesting schedules be implemented? Through DVRFs! Distributed Verifiable Random Functions (VRFs) can create random vesting schedules for each user in a secure way.
ChainSafe R&D is working on a better version of distributed verifiable random functions. More on that coming soon!
About ChainSafe
ChainSafe is a leading blockchain research and development firm specializing in protocol engineering, infrastructure development, co-development and web3-enabled gaming.
Alongside its contributions to major ecosystems such as Ethereum, Polkadot, Filecoin, ChainSafe creates solutions for developers and teams across web3.
As part of its mission to build accessible and improved tooling for developers, ChainSafe embodies an open source and community-guided ethos to advance the future of the internet.