Vesting, Lockups, and Token Distribution Schedules
Founders have several options when it comes to distributing digital assets, each governing legal ownership, on-chain control, and transferability. Understanding the different ways to customize the timing and conditions behind distribution will help you to create a fair and equitable token distribution. Vesting and lockups are some of the most familiar terms to those in the crypto space, but it’s important to not use these terms interchangeably.
While they’re often lumped together, it’s wrong to treat them as the same; vesting and lockups are uniquely different concepts with similarities. We’ll break down each concept and describe the nuances of each, starting with vesting.
What is vesting?
Vesting is the process of bestowing the legal right to an asset. It is often offered as part of a compensation package for employees or service providers. Usually starting on the first day of employment, the vesting process continues on a time-based schedule until the assets are fully vested. Employees leaving a company, either in the case of quitting or through termination, will affect vesting. Unvested assets are typically returned to the company or repurchased by the company.
Vesting schedules
A common vesting schedule is monthly over four years. This would mean a recipient vests 1/48th of their token grant every month, becoming 100% vested after four years. Most vesting schedules follow a monthly distribution, as legal complexity makes it difficult to do so more frequently.
Cliffs
Cliffs are another important part of vesting agreements, representing a point in time before which 0% of the assets are vested, and after which a portion of the assets are vested based on how much time has passed. For example, we often see a fairly common one-year cliff in a four-year vest, where no assets are vested until the one-year mark, and 25% of the asset then becomes vested at the one-year mark. Cliffs are often used to incentivize employees to stay at their place of employment for at least one year, offering a financial incentive to do so.
Why use vesting?
- Vesting is often used to align incentives between projects and employees: Vesting employees’ tokens over several years incentivizes them to stay at the company until they are fully vested.For example, if you’re given a grant of $100,000 of tokens over four years and the token value of your tokens goes up 10x, or even 100x, it is in your best interest to stick around for the long haul, as it may be less enticing to leave before those tokens are fully vested, effectively leaving additional compensation behind.
- Vesting and locks can help to prevent early sell-offs: When tokens are released all at once, it can lead to early sell-offs, depressing the price of the token and even causing harm to the project’s reputation. By using vesting and locks, project founders can gradually release tokens over time, which helps to prevent early sell-offs, which can stabilize the price of their token
- A vesting structure can also benefit employees from a tax perspective: Token grants are taxed either when they are granted or at the time of vesting. If vesting tokens are issued early when the price of a token is low, an 83(b) election can be filed to allow the employee to pay tax on the tokens at the time of grant (while they are worth very little) instead of when they vest, thus minimizing their tax burden. 83(b) is discussed in a separate blog post.
Triggers and other vesting conditions to understand
Different or stacked conditions or “triggers” are often tied to vesting.
- The most basic vesting condition follows a time-based vesting schedule, such as the example of monthly vesting with a cliff. As the vesting dates are hit, the corresponding amount of tokens automatically becomes vested.
- Some projects will add a second vesting condition, such as a liquidity trigger that stipulates that the tokens are not considered vested until the token is launched and trading with a certain level of volume or liquidity. When there are two vesting conditions present, they are often referred to as “double trigger vesting” since both conditions must be triggered for the token to be considered vesting. Double trigger vesting is often used for Future Token Interests or tokens that are expected to vest before liquidity, to prevent a situation where taxes are owed upon vesting on assets that can’t be sold to cover the tax bill.
- Braintrust is a good example of a liquidity trigger with their Future Token Interest program. Tokens are vested only after a certain length of service and a liquidity condition, including a Token Generation Event (TGE), market cap of $220M, and a specific volume threshold.
Tokens, token options, token units, and future token interests can all have unique vesting conditions, whether performance-based or market-based.
When you see “Restricted” next to an asset name (such as Restricted Tokens or Restricted Token Units), that usually implies that a transfer or other restriction, such as vesting, has been applied to it.
What happens when assets are vested?
For tokens that are issued on a vesting basis (usually through a Restricted Token Grant), the first thing to know is that a vesting milestone is usually a taxable event, and the recipient is considered by the IRS to have recognized income equivalent to the fair market value of the tokens that vested at the time of vesting. If an 83(b) has been filed on the particular grant, though, the vesting milestone is not a taxable event and taxes are usually not owed until the tokens are sold.
Once assets are vested, there may still be restrictions on the recipient’s ability to custody or transfer those assets depending on lockups that the project may impose on its holders. This can be a problem from a tax perspective if the assets become vested before they are liquid (and therefore can’t be sold to fully cover the tax bill), which is one reason that some projects will add a liquidity trigger to the vesting.
Vesting ≠ lockup
While they’re often used interchangeably within the web3 space, true legal “vesting” is different from lockups. As we explored above, vesting refers to the process of gradually transferring the legal right to the assets over time, while lockups and unlock schedules pertain to the timeline on which those assets are actually transferred
Many in the web3 ecosystem use the term token vesting to mean any distribution of a token over time, whether that vesting is done via a smart contract, manually by the project, or by a 3rd party such as a custodian. So be on the lookout when that term is used to discern whether it concerns true legal vesting or more of a “when am I gonna get my tokens” unlock schedule.
tl;dr: Vesting = legal claim to the assets, though they may still have transfer restrictions imposed on them.
Unlock schedules
An unlock or release schedule refers to the timeline for when a token will become available for a recipient to trade, transfer, or custody. This may be concurrent with vesting if a digital asset is being distributed to employees. Unlock schedules are usually used for all or most stakeholders including investors, advisors, the community, liquidity, and even to unlock the project’s own treasury tokens to itself. This is an overall mechanism to help control supply and pricing.
The unlock schedule usually starts on the day of the Token Generation Event (TGE), though sometimes it can also start on another important milestone such as an initial CEX or DEX listing. Similar to vesting schedules, unlock schedules can have a cliff (e.g. one year), and a certain length (e.g. four years). Once the tokens become unlocked, they are usually transferred directly to the recipient’s wallet, or able to be claimed from a claim portal.
Why apply an unlock schedule?
When tokens are released all at once, it can lead to early sell-offs, depressing the price of the token and even causing harm to the project’s reputation. By using lockups, project founders can gradually release tokens over time.
In this way, lockups can help control liquidity and sell pressure, and prevent early investors or team members from dumping all of their tokens at the time of TGE. Unlock schedules can also align incentives to keep stakeholders aligned for so long as they are still receiving tokens from their project.
Key parameters
Unlocks can be quite similar to vesting, though they aren’t the same.
The key parameters for an unlock include:
- The total length of the unlock (When will a stakeholder receive all of the tokens they’re supposed to receive?)
- The length of the cliff or initial lockup (When will a stakeholder first receive something?)
- The frequency of the unlock (How often will tokens unlock, and how much will unlock at each interval?)
- - Continuous vs periodic: The frequency of the unlock can either be continuous or periodic. For continuous unlocks, tokens unlock on a second-by-second or block-by-block basis. Some protocols refer to this as “streaming”. During a periodic unlock, tokens unlock with a specific frequency such as daily, weekly, monthly, quarterly, or annually.
- - Linear vs non-linear: When it comes to how many tokens are unlocked at each time step, this usually follows a linear process, where tokens unlock at the same rate with each time step, or an exponential process, where tokens unlock at an increasing rate over time.
Vesting and unlocks can work together
Many projects have both a vesting schedule and an unlock schedule used in tandem. For example, a project might have employees on a monthly vesting schedule but a quarterly unlock schedule. Employees might also vest tokens for years prior to the token launch, and then unlock those vested tokens gradually after the token launch. Even if the employee quits prior to launch, they would still receive the vested tokens on an unlock schedule.
How set in stone are vesting and unlock schedules?
Many projects have both a vesting schedule and an unlock schedule used in tandem. For example, a project might have employees on a monthly vesting schedule but a quarterly unlock schedule. Employees might alVesting schedules are typically established at the time of the token grant or as a part of a broader company token incentive plan (such as an Employee Token Option Plan). Changing a vesting schedule is a legal modification that can have tax consequences for both the company and the recipient.
Lockup schedules are usually more flexible, particularly prior to a token launch. They are sometimes specified in a SAFT, Token Warrant, Token Sale, or employee offer letter. But as a project gears up to launch their token, the exact unlock schedules for each party can get revisited with input from investors, community members, and service providers such as exchanges and market makers.
For this reason, many investor term sheets will specify mutually agreed-upon constraints for their unlock schedules. These can include an upper or lower bound of the tokens reserved for the company or for specific stakeholder categories, and other constraints such as specifying that investor tokens will have a lockup no more restrictive than founder or team tokens.Unlock schedules can vary depending on many factors. In projects where investors have more leverage (usually smaller projects), the investors may command shorter cliffs and shorter total unlock lengths.
So vest tokens for years prior to the token launch, and then unlock those vested tokens gradually after the token launch. Even if the employee quits prior to launch, they would still receive the vested tokens on an unlock schedule.
Distribution schedules are meant to be customized
Different groups of stakeholders such as the team, founders, community, and investors will usually have their own unique unlock schedules, with parameters varying across groups. Investors will usually push to have a shorter cliff and a shorter total unlock length relative to other stakeholders (though some investors pride themselves on wanting long-term unlocks to set long-term alignment with their chosen projects).
If you’d like to learn more about the optimal design of unlocks, Lauren Stephanian from Pantera shared an in-depth breakdown exploring the impact of unlock scheduled on sell pressure.
Final thoughts to keep in mind
While there are similarities between these schedules, with both involving the gradual transfer of ownership or access to assets, they are used in different contexts, and each method has its own unique underlying principles. Vesting schedules are often tied to employment and are designed to incentivize performance, while unlock, release, or distribution schedules are more broadly used to control sell pressure after a Token Generation Event (TGE) and align incentives with different parts of the ecosystem.
You can “lock up” tokens that are then unlocked based on an unlock schedule, and you can vest tokens on a vesting schedule, but the specific vesting schedule, lockup period, and distribution method that you choose will depend on the specific goals of your project.