Guide

How do token vesting schedules work?

December 7, 2023

How do token vesting schedules work?
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Compensation is a key piece in motivating your team to achieve your company’s objectives. There is a lot of variability in how companies create incentives to align their employees’ financial goals with the company’s success.

Crypto Compensation Trends

In the history of fiat, equity and token compensation, equity-based compensation emerged in the 1950s as an alternative to cash incentives, offering employees a stake in the company's success through instruments like Restricted Stock Units (RSU). This approach fostered ownership and loyalty while aligning employee interests with organizational goals.

Similarly in the crypto space, token-based compensation has emerged as a key way for companies to similarly incentivize employees. This is facilitated through different types of token compensation structures, such as Restricted Token Units (RTUs), Restricted Token Agreements (RTAs), and many others.

For token grants such as RTUs, how you set your vesting schedules will heavily impact incentive alignment with your employees.

Using RTUs for Crypto Compensation

Usually, token compensation is done through token grants which are vested and can have lock up periods, and they vest and unlock after specific periods of time. RTUs have become a common choice for token compensation due to their unique features, including:

  • Flexibility: RTUs can be tailored to meet the specific needs and goals of both startups and employees, offering versatility in designing compensation packages.
  • Vesting commitment: Tokens can only be fully-owned without risk of loss by the employee when the tokens ‘vest’.
  • Upside Potential: Employees will often be granted tokens as part of their overall compensation, but those tokens can possibly appreciate significantly by the time the grant has fully vested.
  • Fractional Ownership: RTUs enable employees to hold a fractional share of the platform they are building themselves, aligning their interests with the long-term success of the project.

How RTUs work can be summarized in 2 broad steps:

  • Token grants are designed and executed: The company will decide on the vesting structure of their token grants, and distribute it amongst their contributors. Tokens granted in this way through a vesting structure may be further locked up for a time, even beyond the vesting period.
  • Tokens release through vesting: As milestones are reached in a predetermined vesting schedule (i.e. second year with the company), a specific amount of tokens will vest and be fully-transferred to contributors.

Although a lot more goes into token vesting than the above two steps, it is useful to keep these broad categories in mind when thinking about how token vesting works. We can encourage any company thinking of token grants to be familiar with our guide on the common types of crypto compensation structures.

In this article, we will discuss how vesting for RTU-based token compensation works and what vesting schedule could be ideal for you.

How does token vesting work?

Vesting refers to the moment when full ownership and control over previously restricted tokens is transferred over to the grant recipient with no further risk of forfeiture.

When a token vests, it means that any restrictions or conditions placed on that token are lifted, and the individual or entity holding the asset can now exercise full control, including the ability to sell, transfer, or use it as they see fit, assuming no further lock up period applies.

This vesting occurs on a predetermined “vesting schedule”. Vesting schedules ensure that employees cannot exercise their tokens immediately upon receipt. Instead, they follow a predetermined timeline before the grantee receives full ownership. 

This schedule can be linear, meaning a fixed portion of tokens is released at regular intervals, or it can be front-loaded or back-loaded, depending on the project's goals and strategy.

Vesting schedules are advantageous for companies as they:

  • Promote Long-Term Commitment: By preventing immediate access to token benefits, vesting encourages employees to stay committed to the company's goals and objectives.
  • Align Interests: Employees are more inclined to work towards the company's success when they have a vested interest in its growth.
  • Minimize Risk: Vesting protects the company from losing investments in new hires who may leave shortly after joining.

Token vesting complexities

When tokens vest, the employee will now expect to receive these tokens from you, and you or your employee will be expected by your local tax authority to file the correct forms or withhold the correct amount of taxes.

How you schedule your token vesting across your workforce can strongly impact your HR/payroll workflow, as multiple vests across many days will require multiple off-cycle payrolls to be conducted.

Moreover, depending on the utility of your tokens and the structure of your token compensation plan, your escrow arrangement can play an important role in ensuring your employees qualify for the 83(b) election or that they receive tokens they should receive from an airdrop.

You can learn more on the complexities through our articles on token distribution and tracking, and our legal-focused article around structuring and streamlining token agreements.

Different types of token vesting schedules

Let’s say that you onboard a promising employee, and grant her an RTU of 12,000 of your project’s tokens. 

As an employer you can make the vesting schedule of your RTU in a few different ways. Let’s explore them:

Time-based Vesting

This approach involves a predefined timeline, often with a 1-year cliff and subsequent vesting over a 4-year period. During the one-year cliff period, no token grants are issued to employees in order to protect the company's digital assets from short-term employees.

Timeline RTU granted Cumulative Tokens
Month 1 to 11
No Tokens Granted 0
Month 12 1-year cliff period completed, 3000 Tokens granted 3000
Month 13 250 Tokens granted 3250
Month 14 250 Tokens granted 3500
…. 250 Tokens granted per Month ….
Month 47 250 Tokens granted 11750
Month 48 250 Tokens granted 12000

Milestone-based Vesting

Vesting becomes tied to the achievement of specific milestones, aligning employee efforts with company objectives.

Milestone RTU granted
Completion of Initial Blockchain Architecture 2000 Tokens granted
Successful Testnet Launch 3000 Tokens granted
Successful Mainnet Launch 3000 Tokens granted
Onboard 1,000 developers 2000 Tokens granted
Achieving First-Year Revenue Target 2000 Tokens granted

Hybrid Vesting

A combination of time-based and milestone-based vesting can offer a tailored approach that suits the company's needs.

Timeline RTU granted Cumulative Tokens
0 years with the company No Tokens Granted 0
1 year with the company 1-year cliff period completed, 3000 Tokens granted 3000
2 years with the company 3000 Tokens granted 6,000
Mainnet Launched 3000 Tokens granted 9,000
3 years with the company 3000 Token granted 12,000

Back-weighted Vesting Schedules

In this model, a larger portion of benefits is granted in later years, encouraging long-term commitment.

Timeline Total RTU granted  Tokens Cumulative Tokens
Year 1 10% 1200 (10%) 1200 (10%)
Year 2 20% 2400 (20%) 3600 (30%)
Year 3 30% 3600 (30%) 7200 (60%)
Year 4 40% 4800 (40%) 12000 (100%)

Each type of vesting schedule comes with its own set of advantages and trade-offs, and the choice depends on your company's goals and the nature of your workforce.

Which vesting schedule is right for me?

When considering what vesting schedule is right for you, it’s extremely important to understand your current situation and the pros and cons of different vesting schedules.

Below we discuss some pros and cons of different ways you can structure your vesting schedule.

Shorter Vesting Periods:

  • Advantage: Given the potential high growth and rapid appreciation of project tokens, a faster vesting schedule can be a very strong incentive for employees. In cases of younger companies, many potential employees might be reluctant to sign on to long vesting periods.
  • Disadvantage: There is a risk of higher employee turnover after the shorter vesting schedule ends, potentially leading to worse retainment and less commitment to long-term company goals.

Time-based Vesting with 1-Year Cliff:

  • Advantage: This approach is extremely common, as this schedule ensures employees must be committed for at least a year before they can unlock their tokens.
  • Disadvantage: It might discourage talent who are wary of the risk of getting no upside if they leave before the cliff.

Milestone-Based Vesting

  • Advantage: Tying vesting to specific development milestones, such as user growth targets or product launches, can be very effective in aligning goals.
  • Disadvantage: “Show me the incentive and I'll show you the outcome”. How you design the milestone will greatly impact the incentive alignment of employees, as a poor milestone might mean contributors come to value speed over quality (which can be good depending on your goals)

Longer Vesting Periods:

  • Advantage: A longer timeline helps ensure that employees are committed to the company's long-term success. For bigger projects with good liquidity, employees might be happy to take on longer vesting periods as they believe the token is stable.
  • Disadvantage: This approach would be less attractive to talent looking for quicker rewards.

Back-Weighted Vesting:

  • Advantage: Providing a larger portion of benefits in the later years of employment can be a strategy to retain key talent over a longer timeframe.
  • Disadvantage: Benefits are skewed towards later years, which might not be attractive for employees seeking more immediate rewards.

Before deciding on a vesting schedule, you must deeply consider the status and goals of your project. Very young companies with a very early stage token might require shorter vesting schedules to attract talent, while larger companies with a very liquid cryptocurrency would rather have a longer vesting schedule to maximize commitment from its employees.

Conclusion

In the competitive crypto talent landscape, how you structure and communicate your token compensation scheme matters. 

By selecting the right vesting schedule for your project, you can create an attractive compensation package for the committed foundational talents eager to join your project. 

Toku guides the top organizations in the industry through the complexity of finding the right vesting schedules, and executing them with minimal operational overheads for you.

Make it simple today with Toku.