NFT creators suddenly lose a major source of income

What happened

A growing trend in the NFT space is the elimination of royalties for creators among major NFT collections, marketplaces and platforms.

In the latest example, one of the largest NFT collectives on Solana by floor price (275 SOL, ~$8,250) and trading volume (1.4 million SOL, ~$42 million), the DeGods and their associated pools y00ts and t00bs, announced that they would remove their creator royalties from secondary transactions across the three collections. When the announcement was made, the project founders updated the DeGods collection and specified that royalties would drop from 9.99% to 0%.

Following the decision by DeGods, leading Solana NFT marketplace Magic Eden, which has 77% market share by trading volume, announced that the marketplace would no longer enforce royalties and move to optional royalty payment on their platform. This means that secondary buyers of an NFT can choose whether to pay royalties to the creator.

Curiously, the announcement was made a month after Magic Eden launched MetaShield, a tool that identifies NFTs listed and traded on marketplaces that bypass creator royalties. In some cases, Magic Eden would blur the images of NFTs listed by owners who had not previously honored the royalty payment.

Broader context

NFT creators have two main sources of income: the primary sale of NFTs as well as ongoing royalty payments from secondary transactions paid in perpetuity. Royalties are usually set at a fixed percentage of the NFT price paid by either the buyer or the seller, depending on how the marketplace structures the transaction. The royalty percentage is chosen by the creators and is usually set between 5% and 15%.

Creator royalties were hailed as one of the true innovations in the NFT space, enabling project founders and artists to form a new monetization model that would continually reward their efforts over time.

Ethereum-based decentralized NFT exchange, Sudoswap, was perhaps the first platform to open up the debate challenging the concept of creator royalties by launching its automated market maker that removed royalty payments on secondary transactions entirely. Sudoswap caters to active traders and speculators, and by removing royalties and thus offering better prices, DEX believes it can gain a stronger foothold among the NFT trading community.

Launched in July this year, Sudoswap automated market maker offers NFT trading with fees as low as 0.5%. This is significantly lower than competitor OpenSea which charges a 2.5% transaction fee, plus the enforcer creates the royalty, pushing the total fee closer to 10%. These fees are paid by the seller of the NFT.

Since its launch in July, Sudoswap has done $65.2 million in total transaction volume and accrued $323,000 in platform fees across 33,600 total users and a total of 226,000 traded NFTs. In the same period, leading NFT marketplace OpenSea has done $1.6 billion in total volume over an average of 359,000 monthly active users. Although Sudoswap has offered a compelling value proposition and seen significant growth since its launch, users still choose to trade on the established OpenSea. This may be due to OpenSea’s existing network effects, market dominance and ability to attract both casual and experienced NFT users.

Interestingly, while the removal of royalties could theoretically increase demand for projects, especially in this climate, since the net effect could amount to a 10% discount, in the case of DeGod’s announcement, the opposite appears to be the case.

Before the announcement, DeGod’s floor price was ~390 SOL ($11,700 at the time of writing). The day the announcement was made, October 9, the DeGods floor price fell 36% to a low of 250 SOL ($7,500) and has since bounced back to 275 SOL ($8,250) today. The market clearly indicated that it did not appreciate the move to zero royalties for the collection, raising doubts about how the project founders would remain committed to developing the project over time.

Key quote

“As the old saying goes, ‘show me the incentive and I’ll show you the result.’ This is the iron law of crypto – unless you have a mechanism to enforce something, competitive dynamics will cause it to be discarded,” said Haseeb Qureshi, Dragonfly Capital Managing Partner. “This is exactly what is happening with royalties today. That doesn’t mean it’s the end of the road; people will innovate and try new models that are ultimately incentive compatible.”

Key statistics

According to Magic Eden co-founder Zhuoxun Yin, for the average NFT creator, 92% of their revenue has historically been generated through primary sales and 8% through royalty payments on secondary trades. This points to how the current status quo of primary sales drives the majority of revenue for artists and creators.

Prospects and implications

This industry-wide shift away from royalties has left NFT creators, collectors, and advocates wondering how projects will fund themselves and incentivize founders’ ongoing engagement and commitment going forward.

If the market structure moves toward eliminating royalties altogether, founders and creators of NFT projects will have to be more creative in how they monetize their efforts. The market could see a larger number of primary falls to supplement the revenue loss on royalties. In addition, creators may seek to charge for additional benefits such as concerts, events, merchandise and subscriptions, which may otherwise have been funded through royalties. Creators may also attempt to limit commercial, copyright, trademark and other intellectual property rights on NFTs sold on secondary markets without royalties.

Also, creators may be incentivized to hold back a larger percentage of the NFT collection’s supply in order to monetize their work. For high-value and rare one-of-one projects, they can also choose to fractionalize their work and retain a percentage of the token supply that represents ownership of the piece. However, these solutions are imperfect and treat compensation as equity, rather than providing a sustainable ongoing income stream.

On the other hand, developers are actively working on new token standards designed to enforce royalty payments at the smart contract level. Two Ethereum improvement proposals, EIP-2891 and EIP-4910, aim to automatically process royalty payments across all NFT marketplaces and ecosystem participants, preventing traders and central authorities from circumventing the payments legally entitled to creators.

Even if these proposals prove effective, NFT marketplaces, platforms and participants will need to adopt these token standards and implement them willingly. This will require greater recognition of the value of royalties and the desire to prioritize creator compensation over traders in the wider market.

Decision points

Regardless of which path royalties ultimately follow, investors and collectors must evaluate projects on a case-by-case basis. Although royalties may be compressed or eliminated entirely, tokenization and Web3 technologies will enable new business models that create value for the entire ecosystem.

NFT marketplace Blur recently launched its trading platform on Wednesday targeting professional traders, and it may provide a solution that offers a compelling compromise. The marketplace has implemented incentivized royalties, which encourages traders to honor royalties by not enforcing royalty payments, but by rewarding those who do with the $BLUR token.

Creators must still show that they are committed to providing lasting value to their local communities for the project to succeed. Before creators issue NFTs for sale, they must demonstrate that they are active members of the Web3 community and are able to use their distribution channels to drive engagement and demonstrate the value of their work. They need to clearly communicate the project’s roadmap and systemically deliver on the promises they make, which is a surefire way to build goodwill among the wider Web3 community.

Creators are in short supply, and success stories in the Web2 world have taught us that users and fans will follow their favorite talent. This is why Spotify paid Joe Rogan $200 million to release podcasts exclusively on their platform. That said, creators will take cues from the broader market, and experimentation in the broader market will result in an equilibrium that rewards both creators and their fans.