What Is Crypto Vesting: Explanation for Beginners

UTC by Andy Watson · 6 min read
What Is Crypto Vesting: Explanation for Beginners
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Similar to the more traditional markets, vesting in the crypto space can also engender a spirit of loyalty and commitment for a project among team members.

In 2009, the pseudonymous Satoshi Nakamoto introduced the world to Bitcoin. However, it was not until 2019, with the world deep in the throes of the COVID pandemic, that cryptocurrencies and the blockchain technology underpinning them really came to the fore.

Since then, there has been a veritable explosion of not only cryptocurrency projects, but also non-fungible tokens (NFTs), decentralized finance (DeFi) applications, and decentralized autonomous organizations (DAOs). And while scams have blighted the crypto space, it remains a potentially attractive investment option. But before investors can buy into crypto, a few prerequisites are recommended. The key among them is to have a basic understanding of how crypto works and the various terms, phrases, and concepts that have become commonplace in the industry.

One such term that has gained much traction in the crypto space in recent times is vesting. In this short article, we will look at what the word means and why it is important to crypto projects.

What Is Vesting?

The concept of vesting is not new. Like most of the terms used in DeFi and crypto, vesting has its roots in traditional finance. In the conventional market, companies often include partial ownership of the business in senior or key employees’ compensation packages to motivate them to perform well or stay longer at the organization. The process by which employees acquire equity, stock options, or other employer-specific contributions is called vesting.

In the crypto and DeFi space, during the pre-sale period of an initial coin offering (ICO) or other crowdfunding events, a percentage of a project’s token supply is often put aside in a cold wallet and held for a specific period of time. The process of holding, locking, and releasing those tokens is referred to as vesting.

Vested tokens, which often take up a fairly substantial chunk of a cryptocurrency’s total supply (20-25%), are earmarked for the project’s development team, its partners, advisors, and other assorted contributors. The tokens are used to incentivize the teams to create prosperous and vibrant projects and communities. A few years ago, the average vesting schedule for a token was usually 0-24 months, but nowadays, it can stretch anywhere between 36 and 48 months. This increase in the length of the vesting period is largely meant to foster loyalty and commitment from a project’s management team.

To illustrate how vesting works, let us take the example of a crypto startup setting aside 20% of its token supply for the management team. Those tokens will then be gradually released after set intervals during the length of the vesting schedule. For instance, 25% of the vested tokens may be released after six months, 50% after 12 months, and 100% after 24 months.

Apart from the management team, early investors in crypto projects are also usually subjected to vesting. This is done to prevent investors from selling off their coins immediately after ICOs and IDOs (Initial DEX Offerings), which often creates huge surpluses of tokens in the market and causes their prices to drop massively.

Smart Contracts Are Critical to Vesting

Tokens designated for vesting are usually locked up using a smart contract, and access to them is sealed off until a set of conditions written into the smart contract are met.

Without an effective smart contract, the vesting process can either be manipulated or bypassed by bad-faith actors to the detriment of the project and its investors. Smart contracts are not foolproof and must be audited and tested for vulnerabilities to ensure a secure vesting process.

To confirm the trustworthiness and reliability of a crypto project, it has become standard practice for crypto startups to outsource the inspection of their smart contracts to reliable third-party auditors like SolidProof and Certik. For instance, SolidProof has successfully audited and helped secure over 400 crypto projects and gained a stellar reputation in the process.

Through the use of both manual and cutting-edge automated tests, the German-based firm strives to make sure that smart contracts are up to scratch and that vesting protocols, as well as other key aspects of a crypto project, are adhered to. SolidProof also offers an exhaustive know your customer (KYC) process. The KYC process is the industry standard for authenticating the identities of people behind crypto projects and helps build trust for a crypto startup among potential investors.

Advantages of Crypto Vesting

Vesting in the crypto space is not done for the fun of it. For starters, the process can help prevent “pump and dumpers” from flooding the market with a newly-minted token. Flooding the market with a coin usually lowers the price of the coin and the overall value of the project. But locking up tokens for a period of time creates scarcity and helps the coin retain or even increase its value.

And with the DeFi space reeling from cases of rug pulls and crypto scams, vesting the holdings of team members and pre-launch investors can help protect the crypto community from being taken to the cleaners by fraudulent founders or unethical investors. A project without a vesting process may run the risk of its founders selling off their share of tokens just when the price is high enough and, after that abandoning the project.

The vesting process also gives a development team the time, space, and peace of mind to test, refine, and launch products on their platform without the distraction of selling their stakes right after launching their project. Also, during the vesting period, projects can build their support bases and reach key milestones in their roadmaps without worrying about liquidity issues since there will only be a limited number of tokens in circulation.

Similar to the more traditional markets, vesting in the crypto space can also engender a spirit of loyalty and commitment for a project among team members. A continued financial interest in a project will most likely encourage developers to continue improving and innovating their platform to grow the long-term intrinsic value of their stake.

Final Thoughts

In conclusion, vesting is a key part of a crypto project’s tokenomics. Through vesting, public and private investors can be protected from the price volatility caused by massive sell-offs that often follow initial coin offerings. And if anchored on a secure smart contract, vesting can also significantly reduce the opportunities for rug pulls and pump and dump schemes.

And just as importantly, vesting can go a long way towards ensuring the long-term stability and viability of a crypto startup’s ecosystem by giving its developers a reason to stay in the project. Also, by helping regulate the number of tokens in circulation, vesting can spark an upturn in the price of a cryptocurrency, thus increasing the possibility of the owners of the tokens turning a profit on their investment when they finally get access to them.

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Andy Watson
Author Andy Watson

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