How NFT royalties work – and sometimes don’t

In an age of artists raking in fractions of a cent from music streams and visual artists lacking any revenue share from the speculative secondary market – NFT royalties were turned over as a trump card for artists struggling to set up sustainable business models.

Now, with the move by X2Y2, Looks Rare and Magic Eden to make NFT royalties optional, artists are once again playing defense.

Because the smart contracts underlying NFT royalties lack legal enforcement mechanisms or other outside accountability, it appears that the technology is only as good as the platform’s commitment to maintaining it.

And, with ImmutableX’s rapid launch of a community-managed NFT marketplace blacklist, a number of skeptical artists and NFT collectors have questioned how the technology actually works—and whether artist royalties can be saved.

What are NFT royalties?

NFT royalties are crypto payments designed to give creators a cut of the secondary sales of their digital collectibles. The percentage of sales designated for royalties is set by the creator at the time of minting – usually around 6%. Smart contract platforms where NFTs are minted are in most cases responsible for automating the payments.

The key to the success of revenue sharing lies in previous attempts to establish universal baselines for artist resale royalty rights. It explains why NFT royalties are important to the Web3 narrative and where the system currently falls short of its intended purpose.

Why Artists Need Resale Income

Artists have long struggled to find fair compensation. Artists such as Harvey Ball, famous for creating the yellow smiley face in 1963, were only paid $45 for their iconic image. The T-shirt company that used it later sold for $500,000,000 in 2000. And Robert Rauschenberg in 1958 sold his painting “Thaw” for $900. Just a few years later, it changed hands for $85,000.

Once the intellectual property of both artists left the building, they lost all rights to downstream payments. That would not be the case if they had rights to royalty payments from secondary sales.

Resale royalty rights are the legal right to a percentage of the proceeds from the sale of an original work of art. The right is either granted by the state or a contract between the artist and the dealer. And in the US, except for California, artists can only access this through individual contracts.

In 2013, the United States Copyright Office reported that visual artists are at a unique disadvantage compared to other creators when it comes to monetization.

Because the value of their art is derived from uniqueness, little money can be made from reproduction. The intrinsic nature of visual art excludes it from the type of royalty contracts between musicians, record labels and streaming platforms.

The music industry has its own set of challenges when it comes to fair compensation. The streaming model has cut artists out of a large share of royalties. Projects like Blocktones have found creative ways to get royalties into their music-based NFTs.

Artists in the United States have attempted to establish universal baselines for artist resale royalty rights through legislation, but each attempt has failed. And while some of these rights exist for Californians—and in some countries like France—the requirements are easy to evade due to the lack of enforcement across borders.

The ability to offer artists a simple system to collect royalties from NFT’s resale is what convinced many artists to enter the NFT market. Without royalties, the technology lacks an alternative to the artist’s monetization model.

How NFT royalties work

The NFT royalty system may vary between blockchains, but with Ethereum it is managed at the discretion of smart contract platforms.

With Rarible, for example, the artist can set the percentage of the resale revenue at the stamp stage via a smart contract on the relevant blockchain. At the time of purchase, the platform automatically executes the terms of the contract. Platforms differ in the specific payout plans.

However, the terms do not represent a legal contract – usually in an attempt to avoid litigation.

Example: According to Rarible’s Terms of Service, creators must agree to grant the platform royalty-free rights to all content posted on the platform. So even if the platform enters the terms of royalties via smart contract, there is no legal obligation.

The jurists transfer the enforcement burden from civil authorities to code. However, because the automation still requires the consent of the market maker, a number of difficult enforcement challenges have arisen.

Can you transfer royalties between marketplaces?

Royalty policies from other platforms are not automatically transferred.

OpenSea, for example, only supports royalties on collections – not individual pieces. So if an NFT with its own royalty policy is sold on Rarible, and then listed on OpenSea, the original artist will not see any revenue from the secondary sale. Additionally, OpenSea’s maximum royalty is 10% to Rarible’s 50%.

What are optional royalties?

NFT marketplaces such as LooksRare, Magic Eden and X2Y2 have all moved away from the NFT royalty model. Their new royalty-optional system allows NFT buyers to decide to honor an artist’s royalty policy for purchases.

How? Well, even though the royalty policy is immutable smart contracts, the Ethereum blockchain is unable to enforce token transfer provisions. Any enforcement of the smart contract is inherently voluntary. The platforms simply passed that option on to the buyers.

This means that for all existing and new NFT listings royalty payments are discretionary. Some platforms, including LooksRare, have agreed to share 25% of protocol fees with creators in an effort to mitigate the effects on the artist revenue model.

NFT artists like Tyler Hobbs have started adding NFT marketplaces that avoid royalties to a blacklist.

He blacklisted X2Y2 in his QQL collection following their decision to remove royalties. The move succeeded in blocking the collection from being listed, but platforms can develop workarounds. Some ecosystems like ImmutableX are working on a community-managed whitelist and blacklist that will implement broad enforcement across the Ethereum NFT ecosystem.

Is there evidence that NFT royalties provide sustainable income for artists?

During the first days of NFT launches, many projects and individuals generated millions from royalties on the secondary market. Today, the secondary market does not offer the same.

Bearish market conditions combined with an increasing number of platforms abandoning royalties have all contributed to falling revenues. A look at Yuga Labs’ royalty payouts illustrates this decline:

Many projects have closed down. But NFT collections like DeGods have responded by removing royalties outright.

DeGods launched a pool of 10,000 Solana NFTs in October 2021. The project benefits beyond the resale market by giving DeGods and DeadGods NFT holders the ability to stake and earn utility tokens.

While large projects with external sources of income can afford royalties, individual artists cannot. To illustrate, the NFT collection Fidenza by Tyler Hobbs has earned a total of 3,999 ETH in royalty revenue, according to Flips.Finance. The original coin price was only 0.17 ETH, meaning that the royalty income exponentially outweighed the coin income.

Despite enforcement challenges, resale royalties have a major impact on an artist’s bottom line.

If an NFT transferred from OpenSea to LooksRare, the artists could still see royalties if the artist registered the collection. But as soon as LooksRare made royalty payments optional, the platform’s overall volume rose dramatically, and royalty fees dropped to close to zero.

The economy is driving NFT marketplaces to drop royalties

The incentive for marketplaces to drop NFT royalties is simple. It attracts traders who want higher profit margins on NFT resale.

“Right now, we’re seeing some marketplaces looking for an advantage during the current NFT market downturn, and they’re turning to tactics like eliminating mandatory royalties,” MakersPlace CEO Craig Palmer said in a statement. “MakersPlace has always been a firm supporter of creators, and while this ‘optional’ approach where the buyer decides whether or not to pay royalties may make sense for other marketplaces, it doesn’t fit with our vision for the space.”

In addition to MakersPlace, NFT marketplaces such as Rarible and OpenSea continue to enforce royalties.

In response to Magic Eden and LooksRare switching to optional NFT royalties, Twitter user NFTstatistics.eth explained the economics in action.

Although it appears to be a race to the bottom, the network effects of a single platform’s decision to make royalties optional are limited to the degree of interoperability between NFT ecosystems.

Because Magic Eden supports both Solana- and Ethereum-based NFTs, the marketplace’s move to drop royalties motivates marketplaces on both blockchains to follow suit.

While the trend has grown across both blockchains, it has yet to trigger a similar pattern across NFT economies on the likes of Cardano.

Cardano NFT volume surpassed Solana’s for the month of October, with some speculate demand for royalties as a big reason why. The theory: The artist-friendly layout attracted a new wave of artists and mints.

The future relationship between artists and NFTs

According to critics of optional royalties, this race to the bottom is a desperate attempt to keep users engaged. Yet paying Paul robs Peter in the sense that benefits to traders come at the expense of the artist.

The royalty incentive only works when all major platforms agree to maintain them. If one breaks that discord, it is not long before others follow suit.

The industry seems to be on the way. If it finds a way to enforce royalties at a protocol level — or even a legal level — then it may succeed where lawmakers failed.

But most proposal upgrades seem to have loopholes that allow similar problems to appear.

The alternative is to find another carrot. If NFTs succeed in implementing a sustainable royalty-free business model, others may follow suit.

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