Token Lockups in Crypto explained simply

Token lockups play a vital role in promoting stability and long-term growth within evolving crypto projects. They involve setting a period of time, in which the specific asset (token) cannot be sold, or otherwise transacted with. This is done in order to stabilize the price of a newly issued asset. We will have a further look at why Token Lockups are important, how are they done, and how they differ from other vesting mechanisms. 

What is a Token Lockup?

Token lockup is a simple way of making sure that certain tokens of a crypto project can't be sold or moved for a set amount of time. The lockup is defined as a period of time, usually up to 2 years, in which the tokens cannot be sold, or otherwise moved. 

Project team members, investors, and partners usually agree beforehand on the conditions of the lockup - quantity, method of distribution, and timespan (Vesting period). Before the public sale, their tokens are deposited into a smart contract that automatically releases them after the agreed-upon time.

After the tokens are unlocked, team members and investors gain full access to their share, meaning they could immediately sell them and influence the price. We are usually talking about whole percentages of the total supply, which is a non-negligible part.

The Reason for Locking Tokens

When a startup project issues its new coin/token, some sales are usually done before the official public launch. These include private sales to investors, strategic partners, or rewards for the project's developer team.

Public distribution and sales are done in various ways, including Airdrops, ICOs, IDOs, IEOs, and more.

Private sales: These private sales are done to raise funding for the development of the project. Investors hope that the tokens will appreciate in value over time and often plan to exit the project completely, once the price reaches their desired point. In doing so they drive the price down by flooding the market with excessive tokens.

Founding team: Project team members usually have greater faith in the project's future and are less prone to selling the tokens immediately. It is never a good sign If the team exits (sells their tokens) too early, as it indicates some serious problem from inside the project or a low-level future prospect.

Tokens lockups are a great solution for situations like this, as they prohibit the premature sale of investors' and team members' tokens. 

Different Types of Token Lockups

1. Team and Investor lockups: These lockups are designed for team members, founders, advisors, and investors participating in private sales. Tokens allocated to these groups are usually locked for a specified period and released either gradually (Vesting schedule), or all at once (Vesting period).
2. Network lockups: To maintain network stability and incentivize user participation, some projects implement lockups for users who stake tokens or provide liquidity to the ecosystem. These lockups often come with rewards or incentives, such as higher yields or voting rights, to encourage users to lock their tokens for a longer period.
3. Ecosystem lockups: Projects may lock a portion of their tokens for specific use cases, like funding future developments, partnerships, or marketing initiatives. These tokens are usually released over time or upon achieving certain milestones, ensuring that the project has resources for continuous growth.

Potential Consequences

Positive Effects

Lockups encourage long-term commitment from team members, founders, advisors, and investors, fostering growth and stability. They contribute to price stabilization by preventing large-scale token sales and ensuring a healthy token economy. 

Lockups also provide incentives for users to participate in the ecosystem and help projects allocate resources for sustainable growth.

Risks and Drawbacks

Limited liquidity can make it challenging for investors to sell their holdings or for users to access their funds when needed. Prolonged lockup periods may create a negative market perception, deterring potential investors from participating in a project.

The value of locked tokens could decline if the project fails to deliver on its promises, causing financial losses for stakeholders. Token lockups can sometimes contribute to centralization, where decision-making and control over a project's direction become concentrated in the hands of a few investors or team members.

Comparison with Other Vesting Methods

Apart from token lockups, there are other methods to ensure that early shareholders don't sell their tokens too early. These are the examples of the most prominent:

• Token Vesting: The locked tokens are released gradually over a specified period of time, according to a pre-determined schedule. Whereas in token lockup the tokens are released all at once when the period ends.
• Liquidity locking: Is a way of preventing a large sum of LP (Liquidity pool) tokens to be redeemed for the actual tokens in the pool. Other than locking just one token, a pair, or set of tokens is locked in a liquidity pool, preventing scams, like rugpull.