Empower the Creator of NFTs with respect to Royalty Payments
The Ambition
The argument in favor of NFTs was to make digital items unique and tradeable and empowering the creator through royalties encoded into the smart contract so that they can participate in the subsequent value creation.
The approach seemed straightforward as depicted in Figures 1.
The Problem
Unfortunately, the approach is based on the somewhat naïve assumption that the transaction is on-chain and atomic. Already the sale of NFT poster child, Beeple’s Everydays — The First 5000 Days, illustrated the issue. The sale was conducted through the auction house Christies and the payment was off-chain.
The sale of an NFT could also be decoupled on-chain in two separate transactions as shown in Figure 2. One transaction could be used for the payment and another for the transfer of the item with a decreased or zero payment. Buyer and seller could use different wallets for payments and NFT transfer to obfuscate their doing. This could reduce the royalties paid to the creator potentially to zero.
Such side agreements are nothing new. But in the “old” economy they are illegal in most cases.
Additionally, the splitting of the atomic transaction into two creates risk for buyer and seller. Without an escrow, the buyer might not receive the NFT or the seller might not get the money. But some might think it worth the risk to save on the royalties.
The other problem lies with the marketplaces. The marketplace decides how the transaction is implemented.
The marketplace could choose to decouple payment from transfer as described above. In this case the market should ensure the integrity of the split transaction.
If the NFT is minted on the marketplace, the smart contract designed by the marketplace is being used. The smart contract might not be designed with creator’s rights as primary objective. For example, the royalties, could be turned into an optional tip.
The Solution
A potential solution to the situation is to put the creator back into power. As shown in Figure 4, the creator or their delegate would need to approve the transaction. This would require that creators use a smart contract template which enforces such an approval step.
This seems a heavy-handed approach, but there is precedence for it. For example, Airbnb provides an option where hosts can explicitly approve potential guests, i.e. hosts are empowered to control the transaction.
Alternatively, a delegate could monitor the transactions involving the NFTs of contracted creators and enforce missing royalty payments off-chain.
In either case, royalty term should be spelled out explicitly in the metadata alongside with other terms such as licensing rights, so that they are legally enforceable.
The mentioned delegate is not a fictious entity. There is the EU Directive 2001/84/EC in place since 2001 on the resale right for the benefit of the author of an original work of art. Organizations like the Bild-Kunst in Germany or ProLitteris in Switzerland will enforce the regulation on behalf of the artist (who needs to be a member of such an organization).
Take away
1. Make an assessment if royalty payments are critical to you, for example if royalties are a significant part of your income as a creator.
2. Spell out royalty payment terms in the metadata alongside the licensing terms.
3. Create transparency: buyer and seller should know what the terms for secondary market sales are.
4. Make sure you are in control of your smart contracts, most contracts offered by generic marketplace may not address all your needs.
5. Think about the practicable aspects of approving sales. Is this something you want to do it? Or do you want to delegate this to your agent or gallerist or to an organization such as Bild-Kunst.
