What about NFT royalties? It’s a $1.8 billion question

More than $1.8 billion in royalties have been paid to creators of Ethereum-based NFT series. In fact, just 10 entities accounted for 27% of all royalties, while 482 NFT series accounted for 80% of all royalties to date. The reality is that royalties are not a primitive inheritance of on-chain persistence in the crypto space. Let’s discuss the royalty of NFTs.

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More than $1.8 billion in royalties have been paid to creators of Ethereum-based NFT series. In addition, the average percentage of royalties paid to creators by the OpenSea platform has doubled from 3% to 6% over the past year. OpenSea is by far the platform that pays the most royalties to creators. Major brands in NFTs, including traditional players and native cryptocurrency organizations, have raked in hundreds of millions of dollars in royalties generated from secondary sales. In fact, just 10 entities accounted for 27% of all royalties, while 482 NFT series accounted for 80% of all royalties to date. However, recent resistance to the royalty model by the wider crypto community is threatening what NFTs were once positioned as a core value proposition. The reality is that royalties are not a primitive inheritance of on-chain persistence in the crypto space.

our methodology

How royalties work

Until recently, NFT royalties have been an opaque aspect of NFT transactions. First, royalties are paid by the seller, not the buyer, (similar to the commission model for real estate transactions). Second, royalties are not actually programmed at the token/smart contract level. Specifically, smart contract transfer mechanisms, such as Ethereum’s transferFrom() function, cannot be used to calculate royalties owed, as these functions are also used when collectors transfer NFTs between their own wallets. The only way to write NFT royalties into a smart contract is if the program somehow knows exactly when the owner transfers assets between their own wallets or sells the NFT to a buyer. This would not be possible without introducing: 1.) centralized management in the form of an intermediary to track ownership of wallets and assets; 2.) by allowing intermediaries to revoke a user’s ability to escrow assets based on their actions, Thus weakening the self-sovereignty of digital assets.

In the latest issue of The Chopping Block, Dragonfly’s Haseeb Qureshi and Magic Eden’s Zhuoxun Yin discuss the trilemma between successfully enforcing royalties, decentralization, and Turing completeness. Successfully optimizing all three properties is currently unattainable, which is the key reason why NFT royalties have not yet been implemented at the token/smart contract level.

Due to the technical difficulties of enforcing royalties at the smart contract level, they are instead enforced by the NFT marketplace. In other words, royalties are enforced by social norms, and the market effectively chooses to support creators’ ongoing funding by collecting and paying royalties (similar to tips) on their behalf. As a result, most NFT marketplaces have implemented custom royalty payment solutions to lure creators with the promise of ongoing revenue streams. This was important in early NFTs as the protocol needed to reassure both sides of the market. Over the past two years, the NFT space has matured quite a bit, and the market has adjusted accordingly. As mentioned, some marketplaces, such as SudoSwap, have eliminated royalties entirely to attract as much liquidity as possible.

OpenSea currently accounts for more than 80% of the NFT market transaction volume, and its royalty distribution method is the most common framework on the market today. In this framework, creator royalties are defined at the collectible level and must be set by the collectible owner in OpenSea’s collectible level settings. Along the way, creators will also link a wallet address to the collectible, which will be designated to receive accrued royalties from OpenSea on a regular basis (usually every few weeks). Royalties generally range from 2.5% to 10% of the final sale price. The seller always pays both the royalties and the transaction fee that OpenSea charges on every transaction. These fees are usually extrapolated, and buyers only need to pay the price of the NFT quoted by OpenSea (or the winning auction bid) plus gas fees.

Introduction

NFTs revolutionized the economic relationship between creators and consumers by introducing the concept of creators earning royalties in secondary sales. Before the advent of NFT royalties, artists traditionally only made money from primary sales of their work. This restrictive economic model prevented artists, especially those whose work was seen as too revolutionary at the time, from increasing their revenue streams as their work gained recognition. From a historical perspective, the logic of this restrictive economic model is perhaps best embodied in the famous artist Vincent van Gogh. Van Gogh struggled in poverty all his life, and in the months before his death, he only sold a painting of The Red Vineyard for 400 francs in Belgium. While not well-known during his lifetime, Van Gogh eventually became one of the most famous painters in history, generating more than $670 million in second-hand sales after his death. It’s not hard to imagine a world in which Van Gogh was able to earn royalties from his secondary sales, using these ongoing income streams for his chosen will (such as an art education program).

On the one hand, NFT royalties are a way for creators to earn additional income from the continued success of their work. This business model is especially beneficial for digital artists and musicians, who have historically struggled to recoup profits from traditional distribution channels such as galleries and record labels. On the other hand, there is a growing belief in the crypto community that NFTs should be entirely owned by buyers and that paying royalties to creators is unfair and predatory. Crucially, NFT royalties are currently enforced by the market itself, rather than being hard-coded into issued smart contracts. The decentralized nature of the crypto space has given rise to a variety of NFT market structures that have royalty-free NFT transactions as a core value proposition.

Recently, ongoing issues with the enforcement of NFT royalties at the market level have sparked a wave of change among key players in the NFT ecosystem. The DeGods ecosystem recently removed royalties from all its affiliated NFT collections. The move happened despite DeGods founder Frank defending the royalties several times on Twitter, and he still believes that royalties are the best incentive adjustment mechanism between NFT collectible operators and holders. Some smaller exchanges such as x2y2 have also moved to change (or remove) royalty payments. Additionally, Solana NFT marketplace giant Magic Eden made the controversial shift to make all royalties on the platform optional. Magic Eden’s latest move to eliminate royalties is particularly notable, with the September 2022 release of MetaShield, a controversial tool designed to improve royalty enforcement.

There are compelling arguments on both sides of this debate. While royalties have proven to be a lucrative source of income for collectors, they are not enforceable at the smart contract level. The NFT community appears to be divided on the ideology in favor of royalties, with some arguing that royalties are conducive to the healthy development of the NFT ecosystem and others that they are exploitative and unnecessary. Considering the huge risk of loss of potential revenue streams, this issue has the potential to leave a long-term impact on the NFT space for years to come. In this report, we examine the NFT royalty issue from multiple perspectives and present how we view this critical issue.

A Brief History of NFT Royalties

Compared to the NFT space, NFT royalties are a relatively new phenomenon. CryptoPunks, considered the godfather of PFP, never collected royalties when they debuted in 2017. The official CryptoPunks exchange still does not enforce any royalties on secondary sales. Larva Labs, the creators of CryptoPunks, opted for an alternative business model, opting to hold 1,000 Punks on their balance sheet and occasionally sell them to generate income.

Subsequently, Yuga Labs entered the NFT space with their Bored Ape Yacht Club series in mid-2021, demonstrating the economic appeal of a royalty-driven business model in the process. While BAYC only generated $2.2 million in primary sales when it launched in May 2021, the series has since generated $54 million in secondary sales for Yuga Labs through BAYC’s 2.5% cut of each transaction. To date, Yuga Labs has earned a staggering $140 million in royalties from all of their holdings. Other NFT projects have taken note of Yuga’s success, making 2.5% royalties standard practice. As the NFT market continues to heat up in the second half of 2021, the industry standard of 2.5% quickly rises to 5% (supported by series such as Azuki, Doodles, CloneX, and Moonbirds). Yuga Labs has capitalized on this trend of higher royalties, launching the Otherdeeds series with 5% royalties, and changing Meebits from 0% royalties to 5% royalties. Otherdeeds alone has generated $44 million in secondary sales for the company since its inception in April 2022.

Royalties have only increased since the Otherside land sale frenzy. Take Goblintown, which released a completely free set of collectibles and capitalized on a viral meme campaign on Twitter. Behind the veil of “anti-discord, anti-roadmap, anti-utility”, Goblintowns quietly set a 7.5% royalty (very high at the time) for all secondary sales. This ended up bringing in $7 million for the team, and the series ended up being little more than a meme. The highest royalties are probably the Metaverse collection NFT Worlds. Even though NFT Worlds land prices are down 94% from their all-time high, their 9.5% royalty has netted the team $15 million. The platform has only 235 daily active users. Given the poor performance of the collectibles and lacklustre user growth, some community members were unhappy that the project founders continued to collect royalties.

Users are more price sensitive than before as the wider bear market penalizes NFTs in both price and volume. The market has also started to boycott works that generate ongoing income through royalties. This dissatisfaction with royalties and some recent innovations in market structure eventually sparked a surge of activity in the royalty-free NFT market.

How did we get here?

SudoSwap is the origin of the anti-royalty movement in the NFT space. Launched in July 2022, SudoSwap utilizes the AMM model for NFT transactions (similar to how Uniswap works for homogenized tokens). They use the AMM model to increase the liquidity and market making capabilities of NFTs while minimizing fees. Not only does SudoSwap charge a relatively low 0.5% transaction fee (compared to OpenSea’s 2.5%), but they themselves do not support the execution of any NFT royalties. While SudoSwap’s model is best suited for floor price NFTs, their core value proposition has proven to be very popular with sellers looking to improve their profit margins. Instead of losing as much as 12.5% ​​on royalties and platform fees, sellers are guaranteed to pay only up to 0.5% on each sale.

When SudoSwap started to become the go-to place for selling NFTs, Gem took notice. Gem, acquired by OpenSea last April, is an NFT market aggregator that helps users sweep NFTs on exchanges at the lowest possible prices. Naturally, that means Gem is starting to include SudoSwap in its list of aggregators. This small move prompted the wider NFT community to interpret Gem’s integration with SudoSwap as some sort of endorsement from OpenSea. Soon after, another NFT marketplace, x2y2, followed suit, giving both buyers and sellers the option to pay royalties. Around the same time that x2y2 removed royalties on Ethereum-side NFTs, Yawww made an announcement on Solana-side NFTs making royalties optional. HadeSwap happened to launch later in the summer after Yawww removed royalties on its platform, echoing SudoSwap’s approach to establishing a royalty-free AMM model for Solana NFT transactions. By September, it appeared that the royalty-free movement (which initially seemed to start with Ethereum NFTs) was sweeping Solana NFTs.

Magic Eden has a 90% market share in the Solana NFT market, but its dominance is being challenged by royalty-free alternatives like Yawww and Hadeswap. According to data collated by Tiexo, Magic Eden’s market share began to plummet in October, dropping from 90% to 60% in just a few weeks. In response, Magic Eden announced that they would be setting up optional royalties on the platform to compete on an equal footing with these fast-rising challengers. Since the announcement, Magic Eden’s market share has returned to its previous 90%.

Interestingly, the Solana NFT ecosystem is more sensitive to this ongoing royalty debate than the Ethereum NFT ecosystem, as evidenced by the massive shift in market share from Magic Eden prior to the removal of royalties, and the loss of market share from OpenSea to The zero-royalty market is much smaller. One possible explanation is that Solana NFT traders are more mercenary and tend to be profit-conscious liquidators rather than long-term holders and retail users. On the Ethereum side, there are more high-dollar-value collectibles like Fidenzas and Punks that appeal to perhaps more interest in showing status and storing value in these rare collectibles than selling them for a quick profit a class of buyers. In other words, these high net worth users are not worried about the royalties per transaction.

Tyler Hobbs, creator of Fidenza and QQL’s generative art collection, supports the Ethereum NFT community’s actions in a fundamentally different way than Solana’s NFT community claims. “Serious artists and serious collectors tend to be in Ethereum, not Solana,” Hobbs said. “It’s a better test of these systems, and I think creators are going to put more effort into it when it comes to Ethereum.” “So far, Hobbs is right, because OpenSea, which enforces royalties, is still the dominant platform. In addition to individual creators, big brands like Nike, Gucci and Adidas stand to lose tens of millions of dollars in potential revenue if royalties are no longer enforced. We expect these large-scale traditional institutions and well-known creators to struggle to maintain the royalty-driven revenue stream for their Ethereum-based NFT series.

debate

In this ongoing royalty battle, two main schools of thought have emerged. Those in favor of royalties point to the potential for creators to make more money as projects become more popular. This is because projects tend to have low initial sales at the start, but grow in popularity in the months following launch. DeGods and BAYC are two examples of the NFT family that have jumped upstream in their respective ecosystems in less than a year. Proponents of royalties fear that normalizing their removal will return the NF field to the dark ages of traditional creator incentive structures, like those experienced by Van Gogh.

On the other hand, opponents of royalties claim that enforcement mechanisms cannot be implemented on-chain without serious trade-offs that negate many of the advantages of permissionless blockchains in the first place. Even Solana creator and respected engineer Anatoly Yakovenko admits that the only viable way to enforce royalties at the token level is to reimagine what the concept of ownership is. In his view, NFT ownership can be split between user and creator-defined smart contracts. This would allow creators’ smart contracts to enforce royalties and grant them the power to strip users of NFTs if they fail to abide by the royalty parameters set in the token’s smart contracts. This structure has a glaring flaw in the notion of self-sovereignty, which many believe runs counter to the entire purpose of NFTs. Royalty opponents also argue that collectors in the NFT space are extremely price-sensitive and will increasingly favor the market with the lowest fees. In their view, competing for royalties is impractical, and giving up royalties means creators can better develop more sustainable business models.

Some major NFT players have already provided solutions to resolve and/or enhance the enforcement of royalties.

Initial noteworthy response:

Tyler Hobbs’ QQL mint card project is the first major NFT project to prevent transactions in the 0% royalty market at the smart contract level. This feature filters the contract execution through a blacklist, before allowing them to complete the purchase, the msg.sender (trying to people who buy NFTs) are checked on the list of blocked users. If the msg.sender receiver is detected as a blacklisted user, the transaction will automatically fail. Hobbs blacklisted existing anti-royalty markets. The QQL project draws attention to the fact that if the NFT marketplace has the power to decide whether to follow the royalty system, then NFT creators should also have the power to decide which marketplaces can sell their work.

Although Magic Eden later changed course, they initially tried to counter the 0% royalty movement with a tool called MetaShield. This new optional feature allows creators to track and identify Solana-native NFTs listed on 0% royalty platforms such as Yawww. Through MetaShield, creators of these projects can deliberately modify the metadata of NFTs that attempt to bypass royalty payments. The MetaShield tool not only blurs or erases NFT images, but it also creates an accountability system for buyers. If a buyer purchases an NFT that bypasses royalties and is blocked, the buyer will be held liable for the unpaid royalties. This debt must be paid in order to “release” the protection of the NFT image. While Magic Eden has faced backlash for this buyer accountability system, the company has made it clear that the system is set up to incentivize recognition of creator rights.

Manifold, one of the most noteworthy NFT smart contract developers and tool providers, has come up with an eye-opening solution to the royalty distribution crisis. Manifold has partnered with OpenSea, Rarible, Nifty Gateway, and SuperRare to launch an on-chain contract that makes it easier for markets to comply with the royalties required by projects. The key issue that Manifold is solving is that creators have to manually update the percentage of royalties they want in each market their NFTs are traded on. This is problematic as any emerging exchange will not have a clear idea of ​​what the preferred royalty preferences for existing NFT families are. Additionally, creators will also need to manually update their preferred royalties on each exchange if their royalty preferences change. Manifold is standardizing this tedious process by creating tools that allow creators to update their preferences in one place, on-chain. Manifold calls this a royalty registration contract, and it makes it easy for smart contracts that didn’t previously support on-chain royalties to add them. While royalty registries don’t necessarily help with royalty enforcement, they do make it easier for developers to stick to existing creator royalty preferences in an on-chain fashion. This approach is very similar to that originally proposed in the EIP-2981: NFT royalty standard.

Outlook, conclusions and potential solutions

As NFTs continue to grow, the future of royalties hangs in the balance. While data suggests that Ethereum NFTs still have a large number of users willing to pay royalties, the royalty-free market has shown impressive growth in a short period of time. One thing is for sure: the future of NFT creator revenue hangs in the balance as industry stakeholders weigh the pros and cons of this contentious issue. Only time will tell whether creators will continue to benefit from secondary sales or will lose potential revenue to a “pure” ownership model. As this dynamic market continues to grow and mature, it will be interesting to watch how stakeholders carefully consider potential long-term solutions. Some potential solutions include:

Buyer’s premium : In Beeple’s view, it makes perfect sense to shift the responsibility for paying royalties from the seller to the buyer. As buyers are looking to enter the NFT ecosystem, they may be more willing to pay royalties as they may also take advantage of some NFT-related utility (such as accessing Discord, staking for rewards, or playing games). In all of these use cases, royalty payments can be checked programmatically before the program grants access to the user. Sellers, on the other hand, are likely to be less willing to pay extra when selling NFT collections. So it’s no surprise that sellers are more mercenary in nature when it comes to finding the best strike price for their NFTs. This situation is exacerbated by NFT speculators who enter and exit NFT positions purely for profit.

Vertical integration of the marketplace : When Crypto Punks debuted in 2017, they could only be bought and sold on Larva Labs’ marketplace. By controlling the market, Larva Labs is able to enforce its own royalty preference (which has always been 0%). Today, both Yuga Labs and RTFKT are building their own marketplaces. This trend of vertical integration has a lot in common with the e-commerce trend of the past 10 years. The analogy here is that Amazon is like OpenSea, maximizing distribution and minimizing profit margins. Companies with their own storefronts on Shopify keep more of their profits. While vertically integrated markets are unlikely to account for the vast majority of NFT trading market share, this trend may ensure that some level of royalty collection is always present (similar to what we’ve seen with the rise of direct-to-consumer).

Alternative revenue streams : With royalties no longer guaranteed, some collectibles may be forced to introduce subscription-based business models to maintain their repeatable revenue. Other collections may be forced to monetize IP through merchandising or commercial transactions other than cryptocurrencies (events, restaurants, TV shows, games, movies, etc.). This could be beneficial for the NFT space in the long run as it can force the ecosystem to deliver a long-term strategy, but we wouldn’t be surprised to see many failed attempts at this. When it comes to generating alternative income streams, the key question to ask is, what is the purpose of NFT collections? This approach makes logical sense if NFT collections are supposed to act like businesses. However, members of the decentralized community who believe that collections should not be profit-driven may be disappointed by this trend.

Raise the mint price : The easiest way to address the decline in royalties is to increase primary sales. This approach may only work for already established and successful NFT ecosystems. However, we do see that mint prices are expected to rise over time (just as we saw royalties rise from 2.5% to 7.5% over the past year). However, this tendency to raise mint prices could also lead to an increase in scams due to misaligned incentives. As new projects raise more capital up front, they may be less inclined to provide sustained value over the long term.

Regressive Royalty System : This method originally proposed by jota.sol has similarities to the historical regressive tax system. Under this system, as the tax amount increases, the tax amount will decrease. In the case of NFTs, the higher the value of a particular NFT, the lower the royalty percentage charged on sale. The economic theory that underpins this approach is called the Laffer Curve, which posits that both logically extreme taxes produce suboptimal outcomes in terms of revenue generation. In other words, there may be an optimal royalty ratio that most traders are willing to pay on Laffer Curve, and the ratio is > 0%.

Implement off-chain utility : This is a similar effort to what Tyler Hobbs and metasshield have already attempted, but it focuses entirely on off-chain use cases. The core idea here is that many users buy NFTs to access off-chain resources (such as games, staking platforms, Discord servers, etc.), and this approach will simply check access to that resource based on whether the NFT owner pays royalties. We’ve seen this in NFT Discord servers, where roles are awarded based on past royalty payments. These enforcement mechanisms usually work by checking if the NFT was purchased on a royalty-free exchange such as x2y2. By publicly excluding those who take advantage of royalty-free exchanges, it is possible for buyers to migrate back to exchanges that implement royalty, hoping to preserve the utility of their NFTs.

Editor: In fact, this article focuses on the creator economy, and has carried out a very detailed classification and analysis of the royalties in the NFT field. In fact, there is one part that is not covered, and that is the issue of royalties created by the community . Remember the weightless NFT project Agravity we mentioned earlier? This project has been an example of community co-creation. AG encourages every NFT holder to create a unique storyline for their own Rise; more multiverses will also interact with each other in the future, forming interesting linkages. Different from other types of secondary creations (there are many secondary creations based on screen images), Agravity focuses more on content co -creation (including story trends, scripts, comics, etc.). The project party plans to allow NFT holders to deeply participate in the development process of the IP main universe, and they can also use their avatars to participate in cooperative games and enjoy exclusive rights.

Community co-creation is actually nothing new. Agravity has made a long-term plan for co-creation. At present, the official website has not seen a detailed description of the income of co-creators, but we are looking forward to it. We will always pay attention to the track of creator economy.