Author: Ro Patel, Partner at Hack VC; Translated by: Tao Zhu, Golden Finance
1. Current Status of Token Ownership
A trend in the current market cycle is the issuance of tokens with high valuations and low initial circulating supplies (i.e. “low circulation/high FDV tokens”), which has raised concerns in the crypto community about sustainable upside for public market investors. The large number of tokens expected to be released by 2030 could create potential selling pressure unless balanced by increased demand.*
Historically, contributors* to a protocol network have typically received a percentage of the fully diluted supply of tokens that vested in the term structure. Contributors should be adequately compensated for their efforts while balancing compensation with the interests of other stakeholders (i.e., public market token investors). This is critical because if the portion of vested tokens represents an excessive amount of the token market cap as well as available liquidity, the vesting event could adversely affect the price of the token, to the detriment of all token holders. On the other hand, if contributors are not adequately compensated, they will no longer be motivated to participate in the project, which would ultimately also harm all holders.
Classic parameters for token vesting include: percentage of tokens allocated, cliff period, vesting time, and payment frequency. All of these parameters only work in the time dimension.
However, using only the typical parameters mentioned above limits the scope of solutions to a narrow range. Integrating new parameters can unlock previously untapped value.
In this article, I propose adding a liquidity or milestone-based dimension to enhance and improve upon the existing token vesting schedule models we most commonly observe today.
2. Liquidity
Consider a token vesting schedule adjusted for liquidity. This idea extends the normal vesting structure by implementing a new parameter: liquidity. The definition of liquidity is not an exact science; there are many ways to detect it.
One measure of liquidity is the bid-side depth available on a token, whether on-chain or on a centralized exchange (CEX). The cumulative sum of all bid-side depths has a notional number that we can think of as “bLiquidity”.
Contributors can get an additional parameter in their vesting terms, which is the “percentage of bLiquidity” or “pbLiquidity”, and this number can be theorized anywhere between 0 and 1.
When vesting is activated, the contract can output:
min(the number of tokens mentioned under normal vesting output, pbLiquidity * bLiquidity * token unit FDV)
Here's an example of how this works: Consider a token with a total supply of 100 units, with 12% (12 tokens) allocated to vested contributors at a price of $1 per token. Assume linear vesting over 12 months from the token generation event, no cliff period, and that the token price remains constant for simplicity. Typically, vesting will allow for redemption of 1 token per month, barring other considerations. Now, assume that 20% of pbLiquidity is allocated, and that the token has at least $10 of bLiquidity over 12 months. In the first month of allocation, the contract will look at $10 of bLiquidity, multiply it by 20% pbLiquidity, and get $2. Given the min function above, 1 unit of the token will typically vest because 1 token * $1 is less than $2. However, change the above number to $2 of bLiquidity, in this case 20% of $2 is $0.40, so instead of 1 token being worth $1, only 4/10 of the tokens will be distributed.
Advantage
Previously, allocations really only cared about time, and perhaps indirectly whether there was enough liquidity at a given price to absorb the allocation. This structure explicitly defines that contributors should focus on building liquidity for their tokens, and aligns that goal with tangible incentives.
Unvested token holders (i.e., liquidity market buyers prior to the unlock date) can rest easy knowing that a single vesting requirement will not cause the price to get stuck in a state of liquidity scarcity. Previously, public token holders simply had to trust the goodwill and intent of the token claimers. With this improvement, they now have a clear reason to feel comfortable.
Disadvantages/Challenges
This could result in volatility in contributor payments if the tokens never achieve sufficient liquidity and could ultimately extend the vesting period significantly.
It complicates the simple payment frequency that contributors are used to.
It could incentivize cheating on bidder liquidity. However, there are ways to address this. For example, one could consider bLiquidity being within a certain percentage of the mid-price, or LP positions having some kind of time-lock element.
People can claim tokens from vesting but not sell them immediately, thus accumulating large balances. Subsequently, they may sell all of their tokens at once, which could severely impact liquidity and cause the token price to fall. However, this situation is similar to someone gradually acquiring a large number of liquidity tokens. There is always a risk that large, concentrated holders of liquidity tokens may sell and cause the price to fall.
It is much easier to obtain bLiquidity data from decentralized exchanges in a trust-minimized manner than from CEXs, as the order book data for CEXs is published by the CEXs themselves.
Before we get into the milestone-based dimension, how can projects ensure there is enough liquidity to support a reasonable vesting schedule? One idea is to reward locked LP positions with incentives. Another is to attract liquidity providers. As we wrote in “10 Things to Consider When Preparing for a Token Generation Event (TGE), attracting liquidity providers can help create a stable market by borrowing tokens from the project’s repository and pairing them with the exchange’s stablecoin.
Milestone-based allocation
Another dimension that could improve token vesting timelines is milestones. Milestones, such as number of users, volume, protocol revenue, total value locked (TVL), and similar data points, capture the overall appeal of a protocol through quantifiable numbers.
Of course, protocols can set binary thresholds or gradients for the above parameters, which are incorporated into the vesting schedule. For example, the protocol must have a TVL of more than $100 million, more than 100 daily active users, or more than $10 million in average daily trading volume over the past 90 days. If these numbers are not met, the amount of distribution will either stop completely (binary) or decrease proportionally relative to the initial threshold target (gradient). Between binary and gradient, gradient seems to make more sense.
Advantage
This milestone approach ensures that the agreement has a level of traction and liquidity when vesting occurs, resulting in a healthier agreement over time.
Milestones put less emphasis on time.
Disadvantages/Challenges
Certain statistics (such as active users and number) can be manipulated. The TVL metric is less actionable but arguably less important, especially for more capital efficient protocols. Revenue is also harder to game, but certain activities (such as wash trading) may translate into more fees and thus more revenue, so it is still gameable in the long run. When judging the likelihood of manipulation, it is important to note the incentives at play. Teams and investors (i.e. anyone involved in a vesting program) are incentivized to play with the statistics. Open market buyers are less likely to play with statistics because they have no incentive to cash out faster. Additionally, strongly worded token warrant provisions in off-chain legal agreements can significantly reduce malicious behavior by incentivized parties. For example, if a team member or investor is caught laundering transactions or driving user activity, they may dump their tokens, resulting in severe penalties for rule violations.
IV. Conclusion
The current market trend of high valuations and low initial circulating supply has raised concerns among public market investors about sustainable returns. Traditional time-based vesting schedules may not fully address the complexities of token liquidity and market conditions. By integrating liquidity and milestone-based dimensions into vesting plans, projects can better align incentives, ensure sufficient market depth, and cultivate real traction. Although these approaches pose new challenges, the benefits of more robust attribution mechanisms are significant. With careful precautions, these enhanced redemption models can increase market confidence and create a more sustainable ecosystem for all stakeholders.