The bear market is a time for reflection, which has been perfectly captured by the evolving discussions taking place in the NFT space. Last week it was CC0, and overnight it seems that the new flavour of the week discussion is how we handle NFT royalties.

I’m going to be honest - seeing some of the discussions on Twitter is maddening. People feel they are “arguing” with one another, but in reality they’re discussing entirely different topics and they’re bringing numerous unspoken assumptions to the table.

Rather than scroll on Twitter and try in vain to respond to the hydra-like threads this topic is spawning, I thought I’d give the concept the words it deserves. The first, and most infuriating aspect of all the discussions I see, is that almost no one is actually defining what an NFT is before they start spouting off pro / anti royalty takes

What is an NFT?

My siblings who walk in the light of God, please, for all that is holy, can we actually start defining what we mean by “NFT” before we start arguing? I’ll start by giving my definition, and I’ll continue to go on to explore what I believe to be the other main definitions of an NFT.

In my eyes, an NFT is simply a digital, tokenised asset. That’s it. It’s a digital good. Heck, the original ERC 721 proposal almost called them “deeds”, due to their suggested initial use case being to tokenise land ownership. Almost any asset can be tokenised and represented as an NFT. Art, shares in a company, limited edition shoes, subscriptions, video game assets, reputation within a community - the list of possible NFTs is as long as the list of possible assets. For the purposes of this article, I’ll be talking about ERC 721s specifically, as they are by far the most common NFT standard.

As such, when we discuss NFT royalties, we must describe what asset class(es) we’re referring to. There is no one-size-fits-all solution for royalties, as royalty structures for fine art can and should be different to that of selling a house. Does it make sense for the sale on a secondary market of a Grant Yun 1/1 to have the same royalties as that of an unlimited sale Fortnite gun? Of course not. I’ll explore these two situations shortly, but this brings us to our next point: how exactly do NFT royalties work?

How are royalties enforced?

Well, they’re not. Speaking about Ethereum at least, royalties are purely opt-in. The collection’s contract itself has no way of enforcing secondary sale royalties. What usually happens nowadays is the contract, much like individual NFT, has metadata associated with it. Marketplaces can (and almost always do) read this metadata and extract the collection’s desired royalty percentage. Here’s a quick example:

The Good Minds contract has a contractURI public string, which points to the following data

{
  "name": "Good Minds",
  "description": "Good Minds is an indie, art-focused NFT collection with multiple characters. There are 6000 randomly generated and lovingly curated outputs that exist together on the Ethereum Blockchain. Visit https://goodminds.io for more information.",
  "external_link": "https://goodminds.io/",
  "image": "ar://mdVMRuyZSJd-a0Rge-bwT0WxXUCAQ3aCUYEERDjFg1I",
  "seller_fee_basis_points": 500,
  "fee_recipient": "0x7909938795602232F0c924708783B9B91D168C0D"
}

As we can see here, seller_fee_basis_points is 500, which means 5% secondary royalties. What a marketplace like OpenSea then does is that It reads this data (the collection can also set it manually via the OpenSea website), and on every sale the OpenSea smart contract uses this data to split the sale. Below we can see 0.09 ETH being split 92.5% / 5% / 2.5% between the seller / Good Minds contract’s fee_recipient / OpenSea respectively.

LooksRare and X2Y2 act the same way… mostly. X2Y2 have 0 royalties (neither X2Y2 fees nor creator royalties) for private sales. They can do this because creator royalties are opt-in. Sudoswap specifically don’t honour this creator royalty, and they don’t have to.

Is it possible to enforce secondary royalties on the contract level?

In short, I believe the answer is no. I’ll preface the following with the fact that I’m not yet a Solidity expert, having only started learning it in the last couple of months, so I encourage someone with more experience to weigh in and agree or disagree.

ERC721 tokens are transferred by calling either the safeTransferFrom or transferFrom methods of the collection’s smart contract. For simplicity, I’ll refer to both of these as just transfer, as they both function the same in terms of royalties.

The only way to transfer one of these tokens is to call the contract’s trasnfer. Whether you’re sending the NFT from your hot wallet to your hardware wallet (buy a hardware wallet pls), or it’s being sold on a marketplace, in order to actually move the NFT, transfer is called. Unlike most mint functions on a contract, this method isn’t payable, aka you dont need to pay anything other than gas to call the method. The function signature is defined in the ERC 721 standard, such that for a collection to be an ERC 721, it has to implement this transfer method with the exact same signature.

As such, no ERC 721 token can ever fully enforce royalties, as there has to be a non-payable transfer method.

The only way to enforce royalty fees is with a new token standard, and even then, enforcing token royalties would be difficult and come with significant trade-offs. You would have to have a payable transfer method. Would that mean that if you wanted to vault an NFT, you’d have to pay royalties on the transfer? Could you just sell it to yourself for 0 ETH? But that then means that secondary trades can still happen without royalties by just having a separate contract handle the actual sale. I won’t dive any deeper into this rabbit hole as there are other minds much more equipped to explain this than me, but suffice it to say that an ERC 721 can never enforce royalties.

Ok, so what about the current royalty discussions?

Now that we know what an NFT truly is, and that ERC 721 collections can’t enforce royalties on the contract level, what’s next?

Well, now let’s look at some specific, and well-defined types of NFTs, and whether royalties make sense for them.

10K PFP collections

First, let’s start with the beloved 10k PFP collections (other edition sizes are available). 10k PFP collections often derive their value from the utility / status that comes with owning these tokens. They act as keys to an exciting ecosystem For these collections, I see no royalties as the future.

Now is a great time for us to dig into the idea of incentive alignment. Secondary royalties incentivise collections to generate volume, which could very well be an anti-pattern for many collections. Does high secondary volume mean the project is successful? Should a project be incentivised to have people constantly trading? Once again, it depends, but in many cases I’d say no. Collections being incentivised to create volume is a recipe for what we’ve seen all too often, where they will generate as much short term hype as possible, doing everything possible to capture people’s attention. There are many situations in which a collection wants to incentivise people to hold, and not to trade, potentially to build a strong community with a real focus on a term vision.

Tokenised art

Here is where I believe royalties make the most sense. Art is unique in that in the vast majority of cases, the token holds no “utility” per se. Your purchase of the art is driven by your emotional connection with it, and by your desire to support the artist.

If an artist such as XCOPY releases pieces for a few dollars, which year later sell for hundreds of thousands, the artist should see a meaningful amount of that price appreciation, more than just their ability to list new art at higher price points. I believe we all largely agree on this point too, that this is one of the paradigmatic shifts we’ve seen with tokenised art and that it’s something we should be proud of.

I believe we’ll see this largely supported through the marketplaces themselves. Humans are notoriously lazy creatures of habit. How many of us still go to OpenSea to buy something, even though they may do things we disagree with, while still having the highest platform fee? And before someone says “oh yeah but they have the most liquidity”, how many of us go there without even checking X2Y2 or LooksRare first? Or even Gem or Genie?

For tokenised art, the marketplace that has the best user experience is the one that will set the royalty standards. Discoverability and browsing are vitally important when looking for art. Think about how important it is for an artist to be listed on SuperRare. An artist could make more money by having private X2Y2 listings, or having it be minted directly from the contract, but the majority of art will never be sold that way, and people will happily pay 10% royalties per transaction for the UX and reliability of these platforms.

Tokenised video game assets

Briefly I’ll touch on this third asset class. I see this as being a breakout tokenised asset in the coming years. How many billions of dollars are locked up in siloed video game assets? How much money has been thrown into the endless pit of CS:GO guns, Fornite skins, League of Legends champions, etc?

At first, much like Meta’s marketplace having put o 47.5% fees, we’ll see greedy companies abusing their first mover’s advantage by gouging users. Over time, we’ll see this tend towards 0 (most likely fractions of a percent), as the scarcity of these items is entirely controlled by the creators. Why would Xbox need a 5% royalty on each Minecraft map sold when they could just release a new map and get 100% of its royalties?

Alternative revenue models

The final big benefit in this discussion is that we have the chance to really dig into what the best revenue models are for collections based on their asset class and vision.

For one, I’d like to see some collections try free / cheaper mints, where the collections holds back a meaningful portion of the tokens to sell at a reasonable price at a well-signalled later date.

No MenaceToSociety, this isn’t “dumping” on your holders. Is a company IPOing “dumping” on your investors? Is a movie re-releasing in cinemas “dumping” on your viewers? Ok well for Morbius maybe it was.

In addition, these collections always have the possibility of releasing more tokens once they’ve established a strong community. I’m not talking about your run-of-the-mill companion collection. An example could be how @parallelNFT releases more pack drops, or a collection like Yuga’s Otherside selling more in-game assets (possibly with a discount for anyone holding another Yuga asset).

For asset classes / collections who both want to, and actually can expect secondary royalties, here are some potential ideas around how to structure them.

Collections with a cheap (or free mint) will lean towards desiring secondary royalties, due to them not taking much (or any) capital upfront. In this case though, I could see a tiered royalty system working very well, for example having
* 10% royalties until 500 ETH secondary sales (50 ETH)
* 5% until 5k ETH (225 ETH)
* 2% until 10k ETH (100 ETH)
* 1% onwards
Such that they can launch for free, but raise meaningful capital as they grow.

Collections with a more expensive mint could do away with royalties entirely, or set them to 1-2%.

I believe what we’re going to see is a sort of 3-sided balancing act between:
* Buyer/seller preferences, where the buyers and sellers will tend to use marketplaces whose royalty fee structure aligns with their values
* Marketplace preferences, where the marketplace itself has opinions on NFT royalties. For example, a marketplace aimed at 10k PFP collections might do away with royalties, whereas a curated, high-end, fine art Christie’s style marketplace will favour royalties due
* Creator preferences, where the creator themselves signals the royalty structure they desire, possibly by explicitly stating it, or by choosing specific marketplaces to partner with.

If you take away anything, it’s this: when it comes to the discussion around whether NFTs should come with creator royalties, the answer is that it depends. It depends on the type of asset being tokenised, on the vision of the creator, of the sentiment of the buyers and sellers, and on the marketplace’s aimed at supporting these transactions. And, if anyone spouts a take like “0% NFT royalties make no sense, do you hate creators?” or “NFTs should have no royalties”, without defining what type of asset they’re talking about, they’re begging for an unproductive argument wherein both side are entirely valid but discussing completely different things.

Cheers,

Tygra