Royalties are dead, long live Royalties
Royalties are dead, long live Royalties
There is a problem with royalties & it isn’t enforcement
Dear NFT Artists,
You’re being told that imposing a perpetual transaction tax on your work, irrespective of the re-sale price or utility, is a good idea and fair compensation. It is not and it likely does you more harm than good.
Here’s how NFT royalties work today - you set a royalty % at the time of minting. This is expected to be binding on all future transactions, forever. There are three problems with this approach:
It excludes important market participants like traders, speculators and collectors from having a say in the price structure. This creates an inefficient market which is bad for you.
It does not align incentives because you get paid irrespective of whether the price of the art goes up or down.
It does not take into account how technology has fundamentally altered the market dynamics that resulted in the creation of royalties to begin with.
This problem has been surfaced by emergent market behaviour of prioritising exchanges that bypass royalties. This is possible because they were never enforceable at the protocol level to begin with.
There are novel attempts being made to enforce royalties at the protocol level. Metaplex recently announced a new NFT standard, Hyperspace & Cardinal labs are testing a mint that ensures royalties are enforced.
But, before we rush to find ways to enforce royalties it is worth questioning their effectiveness at serving artists (you) , collectors and the overall art market.
In this essay we’ll make 3 points
Royalties are an economic tool that may be useful in specific circumstances
Resolving enforcement trade-offs: decentralisation, composability >> royalties
Ideas for the ME hackathon: improving royalties, incentivising payment, etc.
Thanks to Abbas, Akshay & Het for inputs that contributed to this essay. And to Vaibhav for inspiring the cover image.
Grateful to John Solow for sharing a copy of his paper with me & to Roland Kirstein & Dieter Schmidtchen for their paper on the economic impact of art royalties.
And finally, h/t to Rory Sutherland, for replying to my cold email with his thoughts on how we can incentivise royalty payments.
Let’s dive in.
Royalties as an economic tool
Royalties were introduced as an economic innovation to allow artists to share in the financial upside of their work.
Before the internet, producing and distributing art was prohibitively expensive. You needed to produce physical copies, transport them, display them in physical locations, etc. As a generation accustomed to e-commerce, we tend to underestimate just how expensive this was before the internet era. For reference, it apparently cost half a million dollars (in today’s terms) to install a single typesetting machine back in 1910. Which is also around the same time as when the Berne convention set a global standard for art royalties as part of wider copyright policy. Point being that when royalties were conceived - markets were physical not digital, price discovery was very slow & it was impractical for artists to distribute and sell their artwork themselves.
Thus, royalties were a tool for artists to contract services of art collectors, distributors, etc while ensuring they share in the profit of their work. This is also why royalties were only paid if the artwork sold above a certain price, and there was often a cap on the amount or time-duration for which artists could claim royalties. Something that’s shockingly missing from current NFT royalties.
It is safe to say, at the very least, that the era of the internet, e-commerce and digital art requires us to question these assumptions and evaluate the effectiveness of royalties as an economic tool not as an intrinsic attribute of NFTs.
Once you think of royalties as an economic tool, you start thinking about their effects on the overall NFT market and its participants.
Collectors and traders who buy early take on financial risk. Most of the art NFTs they buy will probably not sell at all. In a way they have VC like odds, where 1 hit piece pays for 99 misses. When you charge a royalty on that, these collectors will simply be willing to pay less at mint (adjusted for the expected royalty payment at resale) and take fewer bets on upcoming artists. It’s maths.
As a result fewer early artists will be funded. The perverse effect of this is on the most vulnerable artists - those who are unknown or need money instantly. They will be pushed outside the market. They’ll most likely end up forfeiting royalties to gain quick liquidity and accept predatory terms. This would be a market failure and harm the very group that we intended to serve.
As part of my research I came across a paper written by Roland Kirstein & Dieter Schmidtchen on the economic impact of royalties. This one really stood out for me because they analysed the impact across varying sets of assumptions wrt access to capital, resale effort, risk profile, etc. This is a much more holistic framing than making arguments with a few anecdotal cases without providing full context. I’ll summarise their analysis below.
Access to capital.
If you believe that your access to capital is worse than what your first set of buyers have then you’re better off with zero royalties & pushing for a higher price upfront. Because they will be willing to pay more upfront for the same future payoff (better discount rate etc)
If you believe you have comparable or better access to capital given the increased efficiency of markets, availability of risk capital, etc even then you’re better off pushing for an upfront price or holding back a % of the collection instead of asking for a royalty - because now you have a larger time preference. This is also why in 1988 a collective of 40 established artists lobbied against the US congress move to enforce mandatory royalties.
Resale effort.
If you’re expecting speculators/collectors to increase the resale value by displaying, trading, etc then you’re better off negotiating on the upfront price & letting them keep the upside. This way they’re willing to pay more upfront.
If it is your effort or a joint effort then royalties do make sense but they should specify the effort, be linked to its completion and proportioned to each parties expected impact. John Solow argued in his paper that royalties were effective at aligning incentives between the present and future self of the artist.
Risk profile
If we assume that artists are risk-averse then you should prefer a higher assured revenue upfront than the possibility of revenue later on. In this case again, no royalties are better as they will result in higher mint prices upfront.
The point of this section is to communicate that royalties are just one of many economic tools available to you. And academic research seems to indicate that it isn’t a very good one. So instead of feeling obliged to adhere to the dominant narrative of “royalties are pro-artist” you are better off objectively evaluating this for yourself. In the final section we’ll propose improvements that you should lobby marketplaces to implement.
The Enforcement Trade-off
In the rush to enforce royalties we may end up sacrificing what truly makes NFTs special - ownership and composability. It is well established that implementing a tax on NFT transactions will require some level of censorship and surveillance.
An NFT is like any other token, on a blockchain like Ethereum or Solana you can’t restrict its movement without taking custody of some type. Haseeb articulated this best on a recent episode of the chopping block, even blockchains like immutableX which are not fully functional smart contract platforms & only support minting, sales and transfers of NFTs will struggle to restrict OTC transactions etc. Any new standard will need to address intra-wallet transfers, gifts, derivatives, etc assuming it even gets adopted.
If you agree that royalties are, firstly, one of many economic tools, and secondly, losing their effectiveness, then surely these tradeoffs seem unnecessary. Giving up decentralisation for enforcement for royalties feels like modifying the Mona Lisa to support a ticketing standard at the Louvre. It ruins the very thing we’re trying to protect and people will stop showing up to see it.
Going down the implementation path with blinkers on has harmful side effects. For example, the Droit de suite which established the artist’s right to resale royalties back in 1893, made it an inalienable right. Which means that you as an artist cannot opt out of it or go below the 5% threshold it specifies. Maybe this was done with good intentions of protecting artists from predatory terms or maybe it was done to prevent individual artists from making divergent choices - either way, it is inefficient and we’ve been unable to update it.
There is a real risk that in our zeal to force one definition of royalties we end up enforcing measures that create a new set of gatekeepers. Those who promise royalties and end up taking custody of NFTs as the only viable means to enforce them. While they may start out with good intentions, we’ve seen how this plays out. Adopting such protocols can stifle innovation, restrict the size of the art market and damage the very artists it seeks to protect.
So what should we do? That brings us to the next section…
Building the future
Magic Eden announced a $1m fund to support projects that create alternate monetisation avenues for artists & establish incentives to pay royalties while moving to optional royalties on the buyer side.
So buyers on ME can now pay 0, partial or no royalties, sellers receive the full price they’ve quoted. The rationale being that buyers who are entering a project/collection have more of an incentive to honour royalties compared to sellers who are exiting. It also allows for collections to limit perks and access to buyers who honour royalties if they wish to.
In this section we’ll propose a few ideas that we think you should encourage the developer community to build for the Magic Eden hackathon. There’s no greater validation for aspiring teams than knowing that these solutions will wholeheartedly be adopted by the art community.
If you’re a builder, you can apply for the hackathon here, there’s $250k in prizes up for grabs. Please note that we are not associated with the program and have no authority or influence on their decisions.
Before we get in to the ideas, some context on what we think is outside the scope of horizontal marketplaces in the long run,
Verticalization of NFT marketplaces: Kyle Samani wrote about this on the Multicoin blog a while ago and tweeted about this recently as well. Once a community or artist achieves a certain scale it is ideal to set up their own front end. This would include the option to buy/trade/rent the NFTs apart from various other core utilities.
NFTs that are in-game assets, tickets or unlock other benefits: In this case it should be straightforward to enforce utilities at the application level. Using technologies like Magic Shield which can detect whether royalties were paid or not, applications can tie the utility to this.
There’s ideally not much for ME , or any horizontal marketplace, to do in either of the situations listed above. They may do a few things in the short run but given all of the action is currently on exchanges, this will change as vertical players emerge. The ideas we list below will not focus on deep community engagement or utility focus.
We will focus on aesthetic, art, PFP NFTs launched by solo artists or early communities that don’t have the resources/traction to set up their own front end yet and don’t have “in-app” utility associated as part of the NFT.
Improve Royalties
Before anything else we need to improve how royalties are structured. Designing incentives and enforcement becomes much easier once the underlying construct aligns incentives across all participants.
Min threshold price. Royalties should only be applicable if a sale occurs above a certain price. For e.g. if a piece of art was minted for $100, the artist should be eligible for resale royalties if it sells above $1000. Btw, this is how art royalties were originally designed. Yep, they’d figured this out back in the 1890s. The exact threshold price should ideally depend on the initial mint price but any arbitrary benchmark is a good starting point as long as it only taxes transactions where some meaningful upside is created.
Royalties on gains. punk6529 had tweeted about this a while ago and it is a fairly intuitive idea. Just like capital gains are taxed and (most) losses are offset against your tax bill, the same can apply to royalties. Today, if you sell for less then your mint price you are still required to pay royalties - no seller would be happy doing this.
Finite royalty. Today, royalties are perpetuities - no one likes to pay a tax forever. In the traditional art world royalties are often capped to a dollar amount or a time period. Capping the amount to, say $25k, ensures that artists get reasonably compensated and the enforcement and compliance burden is significantly reduced. There is also a psychological element at play, people may be more likely to comply when the burden seems finite and achievable.
Bumper threshold price. We take the concept of a threshold price introduced in point 1 but apply a very high bar to it. This idea is courtesy of Rory Sutherland, who was gracious enough to reply to my cold email. He draws an analogy with patents, where a big fear is that somebody else can make a fortune off your idea while you get nothing. People don’t really mind if others make small profits once they’ve been adequately compensated. So for e.g. royalties can kick in on sales over $100k. In this scenario the artist can share in disproportionate upside and the seller ideally shouldn’t mind paying this given they’ve profited significantly. It is also easier to track and enforce a tax on high value transactions.
Recursive royalties. If the goal is to align incentives across artists and speculators, then the upside from sales should be distributed across everyone who contributed to price discovery. If artists are rewarded for future appreciation of their work, then speculators who bet on artists early should also share in that reward. They assume financial risk and contribute to eventual price discovery. Grum wrote about this in a recent blog post. Although I don’t agree with many things in their essay, the concept is compelling.
Flexible asks. This one can be a game changer. Allow artists and communities to offer multiple pricing options. For e.g. you either pay $100 and a 10% royalty or $500 at mint. This has two benefits, firstly it provides the artist with a mix of upfront payment and future revenue and allows collectors to better balance their exposure. But more importantly, it increases the incentive to honour the royalty because you see it as an economic benefit you chose instead of a forced tax.
Whichever combination of the above recommendations are implemented, the question on enforcement still remains. There’s two things to consider
Willingness to honour. Collectors are more likely to honour a royalty which they perceive as fair, economically viable and one that they’ve selected from a variety of price options. Of course, like with any system, there will be those who try to cheat but my guess is that they will be in a minority compared to what happens today where royalties are seen as a one-size fits all perpetual tax. The stigma associated with bypassing royalties is higher if they seem fair and something you opted in to.
Capacity to enforce. Once royalties become optional and finite it reduces the blast radius needed for enforcement. It also becomes a temporary measure for NFTs that are purchased with royalties to be tracked, controlled by a multi-sig or restricted for the duration of the royalty. Today - these measures would apply to all NFTs, on all transactions, forever. Instead we can restrict them to a fixed time period post mint and monitor specific transactions. It is also easier for communities and people to report violations.
I wouldn’t be surprised if redesigning royalties this way means we don’t need to worry about protocol level enforcement because people are happy to comply with a system that is now perceived as reasonable, fair and voluntary. Just like streaming companies diminished piracy not by preventing it but making the experience of paying for a service superior , the same could happen here.
Now that we’ve addressed how to improve royalties, let’s look at a few other ideas to incentive payment or create alternate sources of income.
Incentivise sellers to pay with alumni status
A counterpoint to the ME argument of buyer side royalties is to incentivise sellers to pay a royalty. This would work in cases where there is a community surrounding the art or a direct relationship with the artist.
Anyone who is exiting the project by selling their NFT can be airdropped an “alumni NFT” if they honour the royalty. You’ll be surprised to know how much people pay for these symbols from their university, for e.g. the Aggie ring costs over $1000. In case of art communities a range of benefits are possible:
At the very least there is a sentimental and signalling value.
Early access to future artwork from this artist
Right to buy back into the project at a discounted price,
Limited access to the community, events etc.
It won’t appeal to hardcore speculators but it might appeal to wide range of art collectors. This is fine, not every tool impacts every person - which is also why it is important to approach the problem holistically and try many things.
Target buyers who pay royalties, via Launchpad
Magic Eden can enhance their launchpad product by allowing artists to target buyers who have paid royalties in the past. This fits in really well with their current approach of buyer side royalties.
At the very least, buyers who pay royalties can be identified with a badge and point system. A whole suite of launch tools can be built which allow artists to communicate and sell to this audience. Drawing a parallel from the web2 ad world, think of this as a “premium audience” targeting capability. Products like Slise , Airdropr, etc. may want to implement this as well.
Any artist who is launching on ME should be able to reach out to buyers who’ve paid sufficient royalties in the past on any collection and
Inform them exclusively about an upcoming airdrop
Beta test incomplete work and receive feedback
Open up collections first to these users
NFT Marketplace Blur has implemented airdrops for traders who pay royalties. I’m not sure if converting this into a governance token for the platform is the best idea - because you don’t want to be governed by people who are overly committed to one economic tool either. Ideally they should be rewarded by the artist who receives the royalty in whichever way they deem fit, marketplaces should have a non-zero but smaller role to play in the actual reward. However, we need to try a lot of stuff out to figure out what works, so h/t to the team for trying.
Creator tools for automating surround content
In cases where a collection gains popularity post-facto, even if the artist misses out on royalties there is a lot of adjacent monetisation possible from the collection. While the original art requires creativity, there is possibly a template around follow-on surround content that makes it easy to automate especially as generative AI gets better and more accessible.
Building tools that allow artists to instantly list replicas, spin offs, merchandise and other related content are valuable at providing them a first mover’s advantage. Collectors entering after the surge in popularity would also prefer to buy from the original artist over vampire attacks etc. A studio that , for e.g., has a generative AI model trained on their initial collection, and an interface designed for the “follow on” playbook will be a valuable tool for artists.
These kinds of tools can minimise the effort needed from artists for issuing such work and help them front-run any vampire attacks. Since ME may have a view on leading indicators of success they could even tip off artists ahead of time saying “hey - now is a good time to think about a follow on for this collection”
Curation & alpha - context.app within ME
On similar lines as rewarding buyers who pay royalties, ME can allow royalty paying buyers to get access to a curated feed from all artists.
This can include collections they are following, NFTs they’re minting, other artists they are following, etc. Basically as someone who pays royalties the product experience should be superior compared to someone who doesn’t. It is important to note that since artists receive the royalty a lot of the improved experience needs to come from that - ME should build the necessary rails. You can think of this as building context.app within ME.
It has always been tricky for marketplaces to build social interactions (e.g. Amazon has nothing on Instagram when it comes to shopping) but art NFTs is possibly one category where it is possible given that people may be willing to pay a premium to hear from artists.
Conclusion
Markets are a timeless & universal information dissemination and feedback mechanism. The reality is that most NFT collectors don’t want to pay royalties in their current form. Rushing to enforce them at the protocol level can have negative consequences for art, NFTs & you, the artists.
A better solution is to treat royalties as one of many tools available, improve royalties such that they make sense for all market participants and build alternate sources of monetisation.