Criteria for determining fair distribution in an ICO - the importance of vesting to align incentives

ICDs are about aligning the incentives of stakeholders

In an ICO, ICD, Crowdsale or similar, the developers usually set aside some portion of the tokens for themselves. This makes sense because it is supposed to help developers align their incentives and act as a reward for a job well done. A well designed smart contract does not merely seek to make the developers or anyone specific into millionaires overnight but instead is a means of creating the right incentive environment to encourage long term commitment to the success of the project and to the development task. Core team members require enough resources to survive and in different environments the costs of survival may differ but these costs are finite. Developers also need the opportunity to get rich as a motivation, but this does not mean getting rich overnight.

Vesting periods

A vesting period assigns a specific amount of tokens locked in a smart contract to be distributed at a fixed rate. This rate can be adjusted within a range by stakeholders as can be the case with delegated Proof of Stake (DPOS) or it can be set in stone for all time. For an example of how this can work let's take a look at the RLC token distribution for the iEx.ec project:

The rate:
It goes... For every season release 250,000 RLC to both of the founders.
A total of 500,000 RLC per season to the founders. A maximum of 2 million tokens is scheduled to be released to the founders out of 86,999,784.

If we assume each RLC is only 25 cents then at 1 million RLC a year it is around $250,000 half of which goes to each founder but if we assume each RLC is going for $1 or more then it's $250,000 a season or $1 million to each founder over four years. As we can see this would make each founder at least a millionaire if they can deliver enough value to put RLC at $1 and keep it there. This alignment of incentives is critical to keep the founders on the same page and one of the aspects about iEx.ec that impressed me is that the founders voluntarily agreed to accept a vesting period of 6 months before every payment. This in my opinion is a good best practice and should be duplicated.

Variable rate vesting periods

Sometimes we might benefit from having less predictable vesting periods. A team member or community member would know when they power up or accept vested stakes that the rate of release can vary. There would be a maximum on one end of the spectrum and a minimum on the other end but the stakeholder would have no way to predict the exact time or rate of the release of their tokens. In this case the release pattern would be more like mining, where sometimes a big amount would be given at once, and sometimes a trickle, but everyone would know by the end of the year they'll get the total amount.

Conclusion

An ICO or ICD which sets aside a massive amount of tokens for the founders without any vesting period is very dangerous for investors. If you put your wealth into a token where founders have for example 10% of the tokens, with no vesting period, then you're putting yourself at risk of being dumped on by the founders themselves. Vesting periods force the founders to stick to the plan and keeps all players as equal in the game. Dumping occurs when there are some token holders who hold large amounts of tokens before everyone else, often the result of giving founders a high percentage of the tokens by default with no vesting period. The compromise here is to give the founders a high percentage of the tokens, but to lock them up for 2 years.

A list of additional for locking them up below:

• Legal, in terms of tax status the tokens being locked up for 2 years will possibly result in a long term capital gains rate instead of short term
• In the situation where the SEC or anyone else sees the tokens as securities, if they are locked up then there is less risk from the SEC.
• Tokens which are locked up are actually perceived as safer. Hackers are less likely to go after tokens which are locked up no matter what for 6 months or 2 years because hackers are notoriously impatient but if millions of tokens can be released instantly then this is something attractive to hackers.

In the future if and when AI comes to interact with the blockchain then perhaps an AI could manifest the initial token distribution. This would in my opinion automate the token distribution to a greater degree, and also the AI itself could determine the rate of release according to it's own criteria and not ours. This would allow for the benefit of machine learning, to determine what the best incentive structure really is, based on many examples and outcomes.

References

Web:

1. https://medium.com/iex-ec/iexec-crowdsale-results-and-kickoff-budget-a1104e4f16e7
2. https://www.entrepreneur.com/article/230207