Since I suggested putting tokens on a vesting schedule in How to Leverage Social Tokens for Long-Term Growth, I have been thinking about the obvious follow-up question - at what point does liquidity get introduced and how? First, let’s illustrate the best and worst elements of liquidity in order to fully understand the implications.
Liquidity as your best friend
The benefits of liquidity are pretty obvious - high liquidity promotes efficient markets and better price discovery for any asset. As an example, maximizing liquidity for any AMM is goal #1 (and often the toughest part of building one) since users want to be able to trade at the "true" market price and with the least amount of slippage, as well as have the ability to do so across a large amount of trading pairs. Applying this concept to social tokens, community members want a tangible way to know the dollar value of their token holdings as well as the dollar equivalent reward with completing a certain task or bounty that the community has designated.
Liquidity as your worst enemy
As I hashed out in my previous post, liquidity attracts speculators - and thus can become your worst friend if you’re looking to build a strong community for the long-run. Liquidity allows people to come in and cash out quickly if they can make a profit and incentivizes dynamics that can maximize the probability of a short-term price increase. The problem is that the resulting behaviors can work against the efforts required to build a community that is earnest in furthering its goal over the long-run.
How to introduce liquidity
Knowing the pros and cons of liquidity, we can arrive at the conclusion that liquidity is necessary but it must be managed in a way that promotes a solid long-term foundation for a community. I believe that the best way to balance this is for a community to introduce liquidity in phases.
Bringing in the concept of a token vesting schedule, we can start to build a framework. Let’s assume that a community uses a 4-year vesting schedule, which begins when the first tokens are issued to community members (all future tokens issued would be vested at the same schedule as the first issuance). In the first year there would be no liquidity - this would allow the community to fully focus on building out its value proposition and optimize for earliest members who are true believers in the community’s mission. After year 1 of a community’s inception, 25% of everyone’s tokens issued would become liquid. This would not be a liquid enough market to provide for good price discovery, but would allow members who need liquidity for whatever reason to cash out a portion of their holdings and on the flip side, allow high conviction people to top up their token exposure. After year 2, another 25% gets unlocked and so on until the end of year 4, when 100% of everyone’s holdings become fully liquid.
Let’s dive into a simple concrete example to fully illustrate this. Assume I am a core contributor to a fictional community that explores how crypto can promote environmental sustainability called "Crypto x Earth", which has a community token called $EARTH:
Initial tokens are issued to those who have contributed work to the community, and I receive 100 $EARTH for building the community’s website. The vesting schedule for the community begins.
I receive another 50 $EARTH for writing three blog posts for the community’s newsletter. Even though I’ve received these 50 tokens 180 days into the vesting schedule, they are put to the same schedule as the first 100 tokens I received.
End of Year 1
My $EARTH balance is 150, and 25% of them, or 37.5 tokens, become liquid. While I decide to hold these because I believe in the long-term of the community, it’s nice to know that I can trade these if liquidity needs arise for me.
End of Year 2
An additional 25%, or 37.5 tokens become liquid. In total, 50%, or 75 of my tokens, are now liquid.
End of Year 3
An additional 25%, or 37.5 tokens become liquid. In total, 75%, or 112.5 of my tokens, are now liquid.
End of Year 4
An additional 25%, or 37.5 tokens become liquid. In total, all of my 150 tokens are now liquid.
In this example, I used a 4-year vesting schedule because that is the standard for traditional company building. However, the crypto ecosystem moves at lightning speed by comparison, and to the extent that a community can build a solid foundation very quickly, it might be worth considering shorter vesting schedules, such as 2 (50% vested per year) or 3 years (33.3% vested per year). Given that there would be zero liquidity to begin, the implication is that no one is able to buy their way into the community in the early days. Access must be earned by contributing work, and I believe this is an added benefit toward the goal of building solid community foundation.
Design liquidity wisely
In the startup world, there’s a saying that goes something like this: you can’t build a skyscraper without building a solid foundation first. So if you’re building a community, will you build a cabin on an unstable swamp that is blinded by the allure of short-term financial gains? Or will you build on a solid foundation first that aligns incentives to create a skyscraper?