Unpacking The NFT Royalties Discussion

We present various opinions and cases for and against royalties, and invite you to take an open mind to each of their merits.

Unpacking The NFT Royalties Discussion

There’s a big debate in the NFT space right now about creator royalties.

One of the promises of Web3 technology came from the ability to sustain a revenue stream for creators via secondary market royalties – where a percentage of all sales between collectors are directed back to the original artist. This is a wonderful way to ensure the artist can capitalize on their own success in the future. For example, typically an artist’s early works become the most valuable but are also initially sold for the least amount - this gives them a way to profit on those later transactions. From the collector standpoint, royalties ensure that the artist can rely on revenue from existing collections versus having to create new supply in the market.

So, royalties are perfect, right? Well, it depends on who you ask, what the project dynamics are and what the current market conditions are. We present various opinions and cases for and against royalties, and invite you to take an open mind to each of their merits. Ultimately, we at Neustreet believe that all participants need a voice at the table.

So How Do Royalties Work?

If I was an artist and launched an NFT collection of a thousand NFTs, I could make money from the initial sale (called the ‘primary sale’) AND from any subsequent sale (called ‘secondary sales’) based on my royalty rate, which I would set as a creator. Many of the biggest NFT projects you see today usually set around a 2.5-5% royalty fee.

This creates a mixture of interactions between three key stakeholders:

  1. The NFT creators, who receive a royalty on secondary sales of a few percentage points.
  2. The NFT marketplaces, which facilitate the sale between buyer and creator and typically add a few percentage points as a fee. For example, OpenSea charges 2.5% and LooksRare charges 2.0%.
  3. The buyers/collectors/traders, who exchange money to buy and sell the NFT, paying both the royalties and marketplace fees.

This worked well in a bull market, where all three parties were benefiting from continued growth in the space. But when the crypto market experienced a downturn, the newly contractionary market conditions exposed a misalignment of interests among those same community members.

How NFT Marketplaces Changed Royalty Policies

Over the last few months, NFT marketplaces started changing their policies as the overall market conditions worsened. The most noteworthy examples came in August, when prominent marketplace X2Y2 announced that buyers no longer needed to pay a specific royalty and that royalties would be optional, set by the buyer. That means whatever royalty fee set by the creator didn’t need to be followed. The buyer could decide what royalties they would want to pay the creator, and could possibly decide to pick zero. X2Y2 continued to charge their 0.5% marketplace fee on top of this.

While X2Y2 already generated backlash from people criticizing their decision, other marketplaces LooksRare and Magic Eden implemented the same policy shortly afterwards. To somewhat soften the blow, LooksRare announced that they will be sharing part of their protocol fee with creators and Magic Eden announced putting $1 Million to a fund building technology to better provide royalties to creators.

X2Y2, LooksRare, and Magic Eden all moved towards a zero royalties model, potentially inspiring other marketplaces to do the same. How did they justify their decision?

There were a mixture of reasons cited:

  1. Royalties are not enforceable on-chain
  • a) While a marketplace can enforce royalty fees on transactions between marketplace users, there are many ways to conduct that transaction off the marketplace. Someone could transfer an NFT from their wallet to another wallet, and simply get paid in fiat or crypto by the recipient separately. There is a process known as “wrapping” a token that can be used to circumvent many smart contract based solutions.
  1. Market competition
  • a) As one marketplace moved to zero royalties, more NFT buyers started moving their activity to that marketplace and away from other marketplaces. In order to remain competitive, marketplaces felt the need to remove royalties.
  1. Other ways for artists to monetize
  • a) It is possible to limit or eliminate utilities such as event invitations, future drops, social platform access, etc. for NFTs that are sold in a way that circumvents royalties, although oftentimes the purchaser of the NFT may not have the prior knowledge that purchasing the given NFT is avoiding royalties. It is also possible for artists themselves to hold back a certain percentage of supply, but that may run afoul of certain regulations.

Backlash and Support for NFT Royalties

Some of the leading figures in the NFT and broader art space were outraged by these announcements, citing royalties as one of the single biggest benefits that Web3 provides artists. In the spirit of NFTs providing new financial opportunities for artists, removing built-in royalties could be seen as cutting away pathways to artist revenue. Many outspoken figures like Betty, founder of the Deadfellaz NFTs, leading NFT artist FEWOCiOUS, and the founders of Yuga Labs, all expressed their anger at marketplaces moving away from royalties.

Other NFT marketplaces have affirmed royalties. For example, Rarible is keeping royalties, citing in tweets, “Royalties are essential to Web3. They empower NFT artists, creators, communities, and new collections.” Rarible also created new incentives like giving people $RARI tokens for paying royalties.

On Monday November 7, FEWOCiOUS sent an open letter to OpenSea asking the marketplace to preserve creator royalties, which was then retweeted by major pop culture figures like Snoop Dogg. Adam Bomb Squad, the NFT project from streetwear brand The Hundreds, cancelled their NFT drop on OpenSea until the marketplace’s position was finally confirmed. Earlier this week, it appeared that OpenSea would be looking into making royalties optional until an official tweet on November 9 affirmed that they would be enforcing royalties for both currently existing and future collections.

There also several reasons why people support royalties:

  1. Fairly compensating artists
  • a) As per the guiding philosophy of Web3, NFTs are creating a more fair and equitable way for artists to generate revenue from their buyers and broader community.
  1. Grows the NFT market
  • a) A lot of the growth in NFT sales and NFT marketplaces has been fuelled by the royalties paid by buyers over the last eighteen months. Keeping these royalties is essential to keep that growth going.
  1. Prevent NFT industry stagnation
  • a) The corollary of the previous point–if creators have one of their key financial incentives removed in making NFTs, this might cause an even further market downturn.

Understanding Different Perspectives

If you think about the three involved stakeholders (creators, buyers, marketplaces), it’s too easy for us to mischaracterize each other as having selfish financial motivations. In different market environments, different people are affected in different ways.

Many creators struggled financially for years until NFTs provided them with a completely new revenue stream, especially at the height of the bull market. It’s understandable that if their NFTs are being actively sold and resold on the secondary markets, they would feel entitled to royalties from sales of their valuable work.

Many NFT holders find themselves in a difficult financial situation as overall market prices have plummeted year to date. Let’s say you bought an NFT at the height of the market and now it’s worth much less. Now, if presented with the need to sell you will have to make a choice between preserving remaining capital and selling the item on an exchange that allows you to circumvent royalties. It’s understandable that someone struggling would want to minimize their losses to secure their own financial situation. Given the dramatic decline in volumes, some NFT holders have had to resort to selling their NFTs OTC (short for ‘over the counter,’ which is more of a direct p2p transaction) where there is no mechanism to capture royalties at the point of sale.

NFT marketplaces that were able to ride the growing NFT wave during times with less creator-collector controversy now find themselves in a different market, with overall NFT sale prices down, NFT trading volume down, and competitive NFT marketplaces opening everyday. It’s understandable that NFT marketplaces would look to things like adjusting royalties as a way to attract or retain more buyers when faced with the alternative of losing them to competitors. At the same time, NFT marketplaces need to balance this with the needs of the creators who create the items to list on the marketplace.

It Gets More Complicated

It’s worth distinguishing the dynamics between different groups of NFT projects. NFT avatar projects that create thousands of NFTs are different from artists and creators who produce 1/1 and smaller collections of NFT art. And even further, there are many situations where NFTs are launched more in the form of blockchain collectible games or company loyalty programs. There are a variety of different applications of NFTs with varying players and unique economics. With nuanced needs and opinions within the NFT industry it's really just the beginning of this discussion on royalties and we are very likely to end up without a one-sized-fits-all solution.

Large NFT collections are where the biggest percentage of royalties are coming from and where most of the conflict exists. For NFT collections, a lot of their participants are traders and the project revenue comes from the royalties from transaction volume, which have decreased significantly in the current market. If the sales prices of a NFT collection are already down, the royalties and marketplace fees are secondary to the decreased overall value of the collection. Some currently NFT collections respond to this by trying to preserve their royalties as a revenue stream in a down market. Other newer NFT collections are not finding much value in royalties given the current market, which is why you see some recent NFTs choosing to launch without royalties or through a free mint.

For 1/1 art, this is where the argument for creator royalties makes the most sense. For an artist, whether they are massively popular or up and coming, the ability to continue profiting off single pieces of artwork that are sold on secondary markets is something most people support. This is especially true considering that an artist’s earlier work is usually their most valuable over time, but usually least valuable at the time of the primary sale. From a collector’s standpoint, royalties may ensure that the artist’s work is more scarce in the future by providing a revenue stream that eliminates the financial need to produce more work. It’s widely considered to be an improvement over the traditional artworld, and the majority of the advocacy for royalty enforcement on social media comes from artists and collectors of 1/1 and small collection digital art.

The current landscape of a few large, generalized marketplaces means a decision made by one marketplace likely has ramifications on both large and small collections alike. Further specialization of marketplaces into sectors which better align incentives of their particular market players is a very likely outcome.

How royalties affect other areas of NFTs - e.g. gaming, collectibles, brand loyalty programs - are still being discussed and have not come to the forefront of this debate so far. Regardless of the emotions behind this debate, it’s good to see the community speaking openly and making progress quickly on the topic of royalties. The discussion has also opened ideas on how artists can monetize outside of royalties.

As people look towards ways we can rethink royalties, here are what some people are suggesting.

  • Holding back NFT supply - If an artist is launching a large collection of NFTs, they can hold back a certain number of NFTs that can fund their ‘treasury.’ An artist can accumulate and slowly sell their works over time in order to support their financial situation, which has also been the case for many traditional artists.
  • Allow lists - Some ideas have emerged to create specific lists of wallets that have previously paid out royalties to creators and only allow those wallets to participate on your marketplace. This also comes with some elements of centralization and control that might be unacceptable for certain proponents of Web3 and decentralization.
  • Token incentives - Marketplaces like Rarible have offered their native token $RARI to buyers who choose to pay royalties, which can form the basis of broad token incentive models that might help encourage more people to pay royalties on marketplaces.

What’s Next for NFT Royalties?

The discussion around NFT royalties will never end, because technology is dynamic, not static. And whatever systems we have in place now to enforce behavior will inevitably change in the future as people figure out ways to work around them. There are several examples in modern history that demonstrate how people have successfully found ways to obfuscate technology.

In the early 2000s, Sony spent millions of dollars creating proprietary disc copy-protection technology called “Key2Audio.” The goal was to prevent people from copying or “burning” music onto other CDs or computer hard drives. The internet responded to the technology with enthusiasm, and soon people found out that you could use magic markers to write on the disc and then these “copy-proof” discs could then be easily copied.

The point is - if people want to find a way around a system, they will find a way around the system. No matter how royalties are ‘enforced’ by an NFT marketplace, people will figure out ways to avoid this. But that doesn’t mean there is no solution to the debate of NFT royalties. Technology can also always provide better opportunities not just for enforcement, but for collaboration.

If we can learn something from traditional economic or financial systems, success comes from when all parties involved have figured out a way to work together. In the dynamic industry of NFTs, we firmly believe there is a long term solution to the issue of royalties that will eventually be discovered. We will continue to update this article as new perspectives emerge and the conversation evolves.