Protecting NFT Artists’ Royalties Under Threat in the Bear Market
In our new installment of WAC Weekly, we had experts from across web3 and the art world discuss the “royalty chaos” in the NFT market. This was one of the main reasons many artists got into web3 in the first place, but in the midst of the crypto crash, several marketplaces have made honoring those royalties an option. We were joined by fx(hash)’s Alfredo Asuzano to talk about the balance between smart contracts and social contracts in creating a fair market that works for artists and collectors.
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The successes and failures of on-chain royalties
In 2017 and 2018, as Blockchain Art Directory’s Fanny Lakoubay tells us, there wasn’t much of a primary market for NFTs let alone a secondary one, nor was there any hype or financial speculation around future sales. But already, digital artists and early adopters were being drawn towards the NFT in part because of its seamless, fully-automated royalties on secondary and tertiary sales.
It’s still a big draw, and not without reason. As research by Galaxy Digital found in October, NFT creators on Ethereum have received $1.8 billion in secondary-sale royalties. This amount of money would be transformational if it was distributed throughout the digital arts sector, but the report found that 80% of those royalties had been earned by just 482 NFT collections, and nearly half a billion dollars (27% overall) was concentrated in just the top 10. And until recently the average royalty payment for creators on OpenSea, the largest single marketplace, had doubled to 6% per sale from 3% the previous year.
On the level of individual artists and collectives, many have had positive experiences with their NFT sales and the platforms and technology partners they work with. But there have been disappointments along the way. Without a very solid technical understanding of smart contracts and other web3 technologies, some artists have found out the hard way that sometimes their royalties aren’t actually enforced by the NFT, just the one marketplace they minted on. If the seller chooses to sell off that marketplace, they get nothing.
This tension has come to a head now that OpenSea has floated the idea of making royalties totally optional on their marketplace. One point of contention here is that OpenSea’s messaging has been unclear, so what’s really going on? And why would an NFT marketplace throw away one of the main things that made NFTs attractive to artists?
Why are marketplaces going “zero-royalty”?
In the midst of the crypto crash, companies are falling apart left right and centre. Earlier this year Coinbase and Binance, two of the biggest crypto exchanges, announced huge rounds of layoffs. Earlier this month a third of those, FTX, imploded over the course of one week and took at least $1 billion of customer funds with it.
As we discussed last week, serious developers in web3 are undeterred, and there’s more of them than ever. But there’s panic all over the industry as companies struggle to stay alive. Several NFT marketplaces, starting with Solana platforms Magic Eden and Sudoswap, have made it optional for resellers to honor royalties in a bid to claw back money that would usually go to the creators. With Solana having had millions of dollars’s worth of tokens stranded in FTX, a significant backer of that ecosystem, there’s less capital to move around and companies will have to cut costs or face closure. But with the bear market biting everyone on Ethereum too, ETH-based marketplaces like X2Y2 and LooksRare have also made royalties optional.
OpenSea has faced significant backlash from artists and other NFT creators, and has said they’re considering that input and will announce their future plans on December 8th. In the meantime, CEO Devin Finzer has written that “it’s clear that many creators want the ability to enforce fees on-chain; and fundamentally, we believe that the choice should be theirs to make — it shouldn’t be a decision made for them by marketplaces.” It’s why OpenSea is introducing a new smart contract for creators that lets them “blacklist” — pre-emptively block — NFT marketplaces that make royalties an option. But with critics of that decision calling the move anti-competitive, it remains to be seen what OpenSea will decide to do.
In reaction to that, several marketplaces have come out and declared that they’ll always #respectroyalties. The movement includes Tezos-based platforms fx(hash), Teia Community, Versum, and objkt.com.
Speaking to this issue, fx(hash)’s Alfredo Asuzano talked about how fx(hash) is making sure royalties can’t be ignored. When someone mints a generative token (or “GT”) from their site, the artist’s royalties are baked into that token’s metadata. If that GT is then sold on a secondary market the token has to “phone home” to fx(hash)’s smart contract in order to be transferred, meaning that the royalties set by the artist can be enforced, no matter what marketplace the piece is being sold on.
Cultural differences in crypto
Discussing some of these recent developments, Joining The Dots’s Yvonne Senouf wondered if a centralized system enforcing royalties across all marketplaces — in all contexts — was against the spirit of the ecosystem. The fx(hash) smart contract lives on-chain and can’t be taken down, it’s “unstoppable code”, but it’s still a single intermediary between all artists, buyers, and sellers of those pieces in perpetuity.
But what do we mean by “ecosystem”? Crypto is no longer a small scene of Bitcoin enthusiasts where everyone has the same core values. As it moves to a “multi-chain” industry with different blockchains specializing in different uses, every chain can split off into its own culture, and this is reflected in the treatment of artist royalties.
It’s notable, for instance, that the marketplaces making the #respectroyalties pledge are all based on Tezos, and, as Decrypt reports, “nearly every Solana NFT marketplace with any significant market share has now rejected royalties or made them optional.” Facing backlash from their users OpenSea, the largest marketplace on Ethereum seems to be moving slowly and carefully on this. Artist Tyler Hobbs told Decrypt “the serious artists and serious collectors tend to be in Ethereum, rather than on Solana. It’s a much better test of those systems, and I think creators will put up much more of a fight when it comes to Ethereum”.
And this emphasis on culture is something Asuzano echoed. While enforcement at the technological level is possible, he tells us he’d prefer to shift attitudes around royalties at the cultural level, emphasizing social contracts over smart contracts. That people on Ethereum and Tezos have different attitudes to digital art shows there is potential to change the culture. And ultimately, the Solana marketplaces are beholden to the sentiments of their users.
In order for royalties to be enforceable at all, it’s important that they’re not seen as a penalty on the collector. What would be more desirable, he says, would be a situation where collectors are insisting that royalties be respected, not having those royalties forced on them by a centralized authority or smart contract.
How impending regulations will force this issue
But as Erika Knierim pointed out, some kind of firm “global standard” applied to all chains and marketplaces might be coming, whether marketplaces like it or not. Regulators in the US have been moving slowly but surely on crypto. But with the dramatic collapse of FTX — whose disgraced CEO Sam Bankman-Fried was personally lobbying lawmakers to shape policy — those regulators have every reason to come down hard on NFT marketplaces.
And it’s going to be very important to regulators whether or not an NFT’s owner sees it as a digital artwork or a financial instrument. As we saw in this year’s Art Basel art market report, NFT artwork is held by collectors for a much shorter time than physical artworks, irrespective of whether those delicate objects are being physically transported around the world from owner to owner. And it’s hard to argue to regulators that an NFT is being seen and appreciated as art when its trading history looks more like arbitrage, or even automated high-frequency trading.
One of the later sites to go “zero-royalty” was LooksRare, a marketplace built on Ethereum, in a move they described as “good for traders, but with a big downside: the move away from royalties has removed an important source of passive income for most creators.” But as covered in Decrypt, a report by analytics firm CryptoSlam estimated that around 87% of LooksRare’s historical trading volume, representing over $8.3 billion, appeared to be the result of “wash trading”.
This is a fraudulent practice where someone trades an NFT amongst their own wallets at ever-increasing prices to create the illusion of a highly liquid asset with a good chance of turning a profit for speculators. When someone “real” buys the NFT in the hopes of making a quick profit, they find that there’s much less interest than the on-chain data suggests. And the appeal of 0% royalties to those fraudulent traders is obvious. When their business relies on fast, automated trading at scale, paying a royalty on each transaction is a penalty that cuts into their already very thin profit margins.
The distinction between this kind of activity and legitimate art trading is a distinction that’s going to have to be made very, very clear. Some kind of standard — one which sellers, marketplaces, and institutions must follow to be accepted as legitimate — might be the only way to be compliant with future regulations. She says: “Companies are being warned, and not so softly, by the new CFTC reports, SEC reports … saying we are going to evaluate these projects on a case-by-case basis. And if you cannot show some other utility or business model — that this is not just a liquidity cash grab — then we’re going to shut you down. Is it a bad thing when these things get deemed securities? No, but what that means is if you don’t have the infrastructure within your company to be regulatorily compliant as a financial instrument, your company will be shut down. All the artists that have run on your ‘standard’ are going to face technological obsolescence … if they joined a smaller blockchain that goes under, their work will be lost. Link rot, all of those things, are now being tested as companies are falling left and right.” As a culture, artists and collectors might not like a world where they have to rigidly police what is and it not art. The dynamism and experimentation that might have been part of the NFT scene until now would suffer for it. But, she continues, “it is something that now with the benefit of technology comes the responsibility of educating yourself on how to use this technology in a compliant and responsible way.”
And Asuzano agrees that this is something that “platformists” have to consider. If well-intentioned platforms are not dotting them is and crossing their ts, its artists who will suffer.
As crypto’s proponents and opponents, token investors, bankruptcy administrators, and lawmakers around the world look at the collapse of FTX, there’s fierce debate around whether this points to a need for centralization, or even more decentralization in the web3 space. Can for-profit marketplaces be trusted to hold themselves accountable for royalties? Or should artists demand that these agreements are enforced at the smart contract level?
Asuzano is skeptical that these things could be enforced at the level of technology without massive centralization. While it’s clear now that regulators are going to set the agenda, he thinks that creating change at the level of culture and community is the way to go. Ultimately, royalties aren’t going to be paid unless people see that it’s beneficial for everyone, and platform operators need to keep their promises to the communities that use them.
WAC Weekly is part of WAC Lab, a new program unleashing the full potential of Web3 for the arts and culture produced by We Are Museums in collaboration with TZ Connect and Blockchain Art Directory, and powered by the Tezos ecosystem.
