This article is from: Hack VC partner Ro Patel

Translator: Odaily Planet Daily Azuma

The Current Design of Token Lock-up

In the current market cycle, the token issuance method of 'high FDV and low circulation' has gradually become a mainstream trend, which has raised concerns among investors about the sustainable investment potential of the market. It is expected that by 2030, a large number of tokens will gradually be unlocked in the cryptocurrency market, and the market will have to bear these potential selling pressures unless demand increases significantly.

As a historical convention, contributors to the network/protocol (including teams and early investors) usually receive a certain proportion of tokens as a reward, and these tokens are locked according to a specific time structure. As the main driving force in the early development of the network/protocol, contributors should indeed be properly compensated, but attention should also be paid to balancing the interests of other stakeholders, especially the interests of token investors in the open market after the TGE.

The proportion here is crucial. If the proportion of locked-up tokens is too large, which in turn affects the token's available liquidity, this will have a detrimental impact on the token's price, thereby harming the interests of all holders; conversely, if contributors do not receive adequate compensation, they may lose the motivation to continue building, ultimately also harming the interests of all holders.

Classic parameters for token lock-up include allocation ratio, lock-up period, unlock duration, and delivery frequency, all of which only function in the time dimension. However, using only these classic parameters limits our imagination for solutions given the current situation. Therefore, we need to add some new parameters to explore new possibilities.

In the following text, I suggest adding dimensions based on 'liquidity' and/or 'milestones' to improve the most common token lock-up models in the current market.

Lock-up Position Mechanism Based on Liquidity

The definition of liquidity is not absolute, and there are many methods to quantify liquidity in different dimensions.

One feasible criterion for measuring liquidity is to check the buy order depth of tokens on-chain and Centralized Exchanges (CEX). By calculating the cumulative sum of all buy order depths, we can obtain a number, which we can call bLiquidity (buyer liquidity) here.

When designing lock-up terms, the project party can introduce two new parameters: bLiquidity and pbLiquidity (i.e., the percentage of buyer liquidity, theoretically any value between zero and one). At the contract level, this can be output as:

• min(tokens to be claimed under normal vesting output, pbLiquidity * bLiquidity * token unit FDV)

Next, we will explain the operation of the lock-up mechanism based on liquidity through an example.

Assuming a token's total supply is 100, with 12% (12 tokens) allocated to contributors with locking requirements, and the price of each token is $1 (assuming the token price remains unchanged for simplification of calculation).

If the lock-up method based on time is adopted, assuming that this portion of the tokens will be linearly released within 12 months after TGE, this means that contributors can unlock 1 token, i.e. 1 dollar, per month.

Assuming an additional lock-up clause based on liquidity is added, if the pbLiquidity value set in this lock-up clause is 20% and the bLiquidity is $10 (i.e., there is at least $10 buyers' liquidity for the token within 12 months). In the first month of lock-up, the contract will automatically check the bLiquidity amount of $10, multiply it by the pbLiquidity value of 20%, and the result obtained is $2.

According to the min function provided in the previous text (taking the minimum value between the classic mechanism and the extra mechanism), the contract will automatically release 1 token, because the release value according to the classic mechanism (1 USD) is less than the release value according to the extra mechanism (2 USD). However, if we change the bLiquidity parameter in the previous text to 2 USD, the contract will automatically release 0.4 tokens, because the release value according to the classic mechanism (1 USD) is greater than the release value according to the extra mechanism (20% * 2 USD = 0.4 USD).

This is a potential way to dynamically adjust the lock-up structure based on Liquidity.

Advantages

• The mainstream lock-up models in the current market mainly focus on the time dimension, and perhaps indirectly pay attention to whether there is enough liquidity at a specific price to absorb the unlocking. The lock-up model based on liquidity requires the project party to actively pay attention to building liquidity around its tokens and combine it with specific incentive measures.
• For investors in the public market, they will also gain stronger confidence transmission-they will only unlock the reserved token quota when there is sufficient liquidity. Otherwise, they will only unlock a portion of the quota that matches the liquidity status, thereby avoiding a big dump in token prices due to insufficient liquidity.

Potential Challenges

• If the token fails to obtain sufficient liquidity support, this may lead to a significantly extended period for contributors to receive rewards (unlocking).
• Additional rules may make the calculation of token unlocking frequency and period more complex.
• May incentivize fake buyer liquidity. However, this can be mitigated in various ways, such as considering only selecting a certain proportion of bLiquidity near the current price, or only considering LP positions with certain lock-up restrictions.
• Contributors can continuously obtain tokens from unlocking contracts without immediately selling them, gradually accumulating a large amount of balance. Afterwards, they can sell all tokens at once, which may have a significant impact on liquidity and cause the token price to fall. However, this situation is similar to whales actively accumulating a large amount of tokens in circulation, and the risk of whales closing all positions and causing price drops always exists in the market.
• Obtaining bLiquidity value within CEX is more difficult than obtaining it in DEX.

Before discussing the milestone-based lock-up mode, the project party should consider how to attract enough liquidity to ensure the "normal" unlocking progress. One potential approach is to incentivize lock-up LP positions, while another approach is to find ways to attract more liquidity providers — as we wrote in "10 Things to Consider Before TGE", allowing liquidity providers to borrow tokens from the project inventory to attract more participation and create a more stable market around their own tokens.

Lock-up Position Mechanism Based on Milestones

Another additional dimension that may improve the token lock-up model is 'milestones', such as user count, trading volume, protocol revenue, total value locked (TVL), and other quantifiable data parameters, which can be used to evaluate the protocol's attractiveness.

Similar to the lock-up design based on liquidity mentioned earlier, the protocol can also design a binary token lock-up clause by introducing additional parameters for various milestones.

For example, to achieve 100% 'normal' unlocking, the protocol must reach a TVL of 100 million USD, 100+ daily active users, and a daily average trading volume of over 10 million USD, etc. If these values fail to meet the standards, the final unlocked token amount will be lower than the initially set target.

Advantages

• Milestone-based lock-up mechanism ensures that the protocol will have certain attraction and liquidity when the token starts to unlock in large quantities.
• Less dependence on the time dimension.

Disadvantages/Challenges

• Data can be manipulated, especially statistical data such as active users and trading volume, which are more likely to be manipulated. On the other hand, the TVL indicator may be less susceptible to manipulation, but its importance is relatively low for certain projects with high capital efficiency. Revenue is more difficult to manipulate, but certain activities (such as wash trading) can be converted into more fees, thereby generating revenue, so indirectly it is still manipulable.
• When evaluating the possibility of data manipulation, it is most important to pay attention to the motives of different groups. Both teams and investors (i.e., the groups involved in the unlocking plan) have motives to manipulate statistical data, while investors in the public market are unlikely to manipulate statistical data because they have little reason to accelerate unlocking.
• Off-chain legal protocols may greatly reduce the malicious intentions of the motivated group. For example, projects can establish severe penalties for rule violations in advance, such as depriving team members or investors of their original token shares if they are found to engage in wash trading or other data falsification.

Conclusion

The current market trend of 'high FDV and low circulation' has raised concerns among public market investors about the potential for sustainable investment in the market.

The traditional lock-up model based solely on the time dimension cannot match the complex market environment. By integrating dimensions such as liquidity and milestones into the token lock-up terms, the project party can better align incentives, ensure sufficient depth, and ensure the attractiveness of the protocol.

Although these new designs also bring new challenges, a more robust lock-up mechanism clearly brings more benefits. Through careful design, these improved versions of lock-up models can effectively enhance market confidence and create a more sustainable ecosystem for all stakeholders.