NFT Royalty Controversy: Should I Pay? To whom?

Sep 18, 2022

Author: Maverick

Editor: Colin Wu

Since September, the hot discussion on NFT royalties and related reform measures has even covered up the market with declining volumes.

Sudoswap pioneered NFT+AMM, which allows project parties to generate fee income through LP market-making in lieu of royalties, thereby benefiting the buy-side. With the advantages of aggregators diminishing, X2Y2 boldly pushed for royalty reform in an attempt to cede the right to pay royalties to the buyer, turning them into tips, or even not paying them. But the backlash and resistance from crypto CTs and artists caused an uproar, and eventually the decision to pay royalties was returned to the NFT community to vote on their own. Magic Eden is the opposite of X2Y2’s choice. MetaShield was launched with creator protection in mind, giving creators the ability to review NFT listings and sales that bypassed royalties, as well as the ability to warn potential buyers by labeling the NFTs of users who bypassed royalties as “debt”. In essence, the NFT marketplace’s royalty determination and strategy is nothing more than one of its marketing tools to cope with the challenges of a bear market.

The question of NFT royalties encompasses at least two issues, one being whether they should be paid and the other being to whom they should be paid, and the questions that arise from these two issues regarding the liability of the NFT platform, other sources of revenue, etc.

Before that, it is necessary to define a few major subjects: project owners, creators, investors, communities, and marketplaces. Many arguments about royalties are mixed on the subject.

(1) Project owners: This refers mainly to the project side of the NFT subject, which creates the framework and narrative of the NFT project, composes the drawings, and makes the ongoing operations and marketing, and includes people with different roles in the team. They are part of the community and are often the first to hold the NFT. In most cases, the creators are part of the initial members of the project owner, with relatively aligned interests.

(2) Creators: In most cases, the creator as an individual is one of the founding members of the project, but not exactly equal to the project party. Secondly, they exist as independent creators or as a community of artists, in which case the creator is the project owner, specializing only in creation, while operations and marketing are mainly initiated by the community. It can also be outsourced, not a member of the project’s creation, paid a one-time fee, and not entitled to subsequent flow of income. (This article refers to the first case by default)

【A simple distinction is made between the first and the second scenario: who pays who for the revenue. In the first case, i.e. the vast majority of cases, the creator is part of the team and is primarily responsible for the production of the graphics and subsequent secondary creation. The royalties are distributed to the entire project team, including the creators, community operators, finance, marketing, etc. The finance role then pays a portion of the royalties to the various members of the team as a daily wage. In this case, the address receiving the royalty income may be a multi-signatory. In the second case, the creator receives the royalty income from his own independent address. After receiving the royalty income, the creator can also grant funds to the community or contributors, or may be completely exclusive.】

(3) Investors: buyers and sellers of NFTs. By buying NFTs, investors become part of the community; by selling NFTs, it does not exactly mean that the relationship between the community and them is severed; they can still communicate or contribute to the community in other capacities, but they do not enjoy the benefits that come with being a holder.

(4) Community: generally contains project owners, creators, investors, non-holders of the lurkers. The identity of the community members, can be intersecting, for example, he entered as an investor, and later felt that the project has a prospect, through the recruitment of applications, and then become one of the members of the project side of the promotion or other role positioning. In addition the relationship is also complex, he can be either the holder of this NFT project or another, but also the NFT marketplace side of the platform token holders, but sometimes in the interests of multiple parties intertwined and contradictory, according to the principle of rational economic man, often choose the most beneficial to them.

(5) Marketplaces: The NFT trading platform itself, often the team of the marketplace, i.e.

To pay or not to pay

At present, as the only means of continuous income for project parties, royalties are inevitably payable, but not all NFTs are worth paying, and the determination of the reasonableness of the royalty rate for different projects requires the marketplace to set rules to participate in order to protect the weaker party between different subjects.

(1) The payment of royalties is a recognition of the intellectual property rights of a project. It is a very contradictory psychology to truly believe in a project and decide to buy it, but not be willing to pay royalties for the good project. For most investors, buying a bullish project is bound to bring a greater return on investment in the future. Not being willing to pay royalties for a good project means not providing the project owner with the necessary funds for ongoing operations and maintenance, and then when the project owner runs out of initial sales revenue, it is bankrupt. How can a bankrupt project owner create higher value for the future of the project?

(2) Royalty rate determination. Although there has never been a uniform standard for determining royalty rates, some projects set high royalties in the name of increasing long-term holdings, which is indeed a pain for investors. The royalty rate should be determined by considering the popularity of the creator or founding team members, the quality and quantity of the NFT, the exclusivity of the rights granted, the value of the IP, the potential market demand, and other factors. In the currently established blue-chip NFT market, the existing royalty rate of a blue-chip NFT should be used as a standard for setting royalties for a new project. In addition, each NFT marketplace should be equipped with an instant voting feature that allows for changes to the publication royalty rate after a successful community vote.

(3) Not all NFTs should be paid royalties. The marketplace should restrict the receipt of royalties for (suspected) Rug Pull NFT projects and needs to define Rug Pull. One is to allow the holder to initiate a vote on their own, and the other is to judge based on the volume of transactions, social media activity, etc. For example, the official Twitter has not been updated for a long time, and the Discord community has been left unmaintained for a long time. After the restriction is made, the subsequent royalty income should be handed over to the new team initiated by the community; if the community has collapsed, the subsequent royalty may be distributed to the holders, or the royalty may be directly reduced to zero.

(4) NFT projects have a single revenue structure, and royalties are not the only sustainable income. At present, the revenue of NFT projects mainly comes from initial sales and royalty flow, with initial sales being a one-time income.

Sudoswap’s innovation lies not only in its AMM curve, but also in its exploration of a sustainable revenue path beyond royalties. It offers the idea that project owners can set aside a portion of their NFTs and combine them with the ETH earned through initial sales to form a Pool, which can generate ongoing LP royalty revenue after attracting enough NFTs and ETH to be traded in the official Pool.

Other ideas are to turn NFT into IP, so as to cooperate with industry manufacturers of Web2 or as a bridge to enter Web3, such as the cooperation between The Weirdo Ghost Gang and clothing brands delicates, in order to bring more external revenue.

In any case, more means to generate revenue in the future does not mean that royalties are less important, and more ways to generate revenue means that the value of giving back to the community can be more diversified and not just trying to grow the floor price.

(5) Marketplaces do not only provide trading, but also take more responsibility to provide services and protection. Magic Eden launched MetaShield to make it possible to examine “tax evasion” investors and label them as “debt”, which to a certain extent protects the project owner or creator’s subsequent source of income. X2Y2 recognized its mistake in time and returned the final decision on royalties to the community, protecting the collective interests of the community, while the governance function launched in the meantime allows holders to participate in voting instantly, a move worthy of emulation by more marketplaces.

To whom

In general, royalties are paid by default to the project owner, i.e. the multi-signature/independent address left by the project’s founding team. As we defined at the beginning, the project owner is not exactly the same as the creator, not exactly the same as the community, and at some point the distribution of interests between different subjects may be contradictory or divergent. I think the marketplace should be involved in the distribution of royalty payments.

(1) The distribution of royalty income can be done at the initial receipt stage. At present, the marketplace takes a certain address of the project party as the means of receiving royalties, which is too simple and non-transparent. Most projects with a roadmap will clearly define the subsequent distribution of the revenue received, such as what percentage of marketing, how much is salary, and even the distribution of salary for different personnel. At the beginning, the revenue received from the platform can be distributed to different addresses according to a predefined percentage, thus avoiding disputes in the follow-up of unknown transfers and opaque use.

(2) For projects that have explicitly abandoned their projects or returned to the community, they should not continue to receive the royalty income after their exit. The marketplace should disqualify the old project owner from continuing to receive royalty income and distribute the subsequent income to a new team elected by the community.

The current debate on royalties is not only about royalties per se, but also about the single revenue structure of NFT projects and the increasing mismatch between the protection measures of the marketplaces for different subject, which are becoming increasingly contradictory. Both NFT project parties and marketplaces face their own challenges in the course of the bear market, but in no case should they benefit at the expense of one subject, and should make more transparent concessions in the face of profit. As an investor, you can’t judge a project/platform only by its floor price and profitability either, any project needs active promotion and support from users.

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