NFT Royalties: Building Passive Income for Creators
Carolyn Davidson, also known as the “logo lady,” is an anomaly in the design world. Initially hired in 1971 to create charts and graphs for Blue Ribbon Sports, Davidson was asked by CEO Phil Knight to come up with a last-minute logo for a line of running shoes the company was about to launch.
Davidson created five designs for this project. The one selected continues its reign as the most iconic logo in sportswear today. Davidson completed this project for $35. Aptly named the “Swoosh,” her logo went on to catapult Blue Ribbon Sports into a major international brand, now known as “Nike.”
To show his appreciation, Knight later presented Davidson with 500 shares in the company, which she still owns today. These shares have since been split and are now worth around $1,000,000.
Davidson’s story is far from the norm for most artists, designers, illustrators, or other creatives. Because usually, when a creator completes a piece of work for a client, the client owns that work. The client then uses that work for branding, promotion, and anything else that might generate revenue — with none of this ending up back in the pocket of its original creator.
What are NFT Royalties?
Royalties are standard in most creative industries like television, film, music and digital media. But visual art is not traditionally a royalty-based profession. When a visual artist completes or sells their work, the artist is paid. At this point, the work no longer belongs to them, but to their buyer. If that buyer sells the work for a profit, none of this profit ends up back in the hands of the artist. This is the case for many other types of creators as well. But this is the old model.
The new model [made possible by NFTs] provides the opportunity for all creators, including visual artists, to earn royalties — or passive income — on their work indefinitely.
What is Passive Income?
So, if you’re totally new to this, passive income is making money by simply holding assets or investments. Think collecting rental payments on a property or holding company stock in your portfolio that yields a regular payout.
How do NFT Royalties Create Passive Income?
Let’s circle back to the example of a project in the entertainment industry here. Traditionally, when a project in this industry gets made, everyone involved signs a contract. This contract outlines how each participant gets paid. Payment can be cash up front, separate payments based on project milestones, or any number of other ways that allow the participant(s) to get compensated for their work. Either way, most actors, musicians, producers and others involved in these projects have royalties included in their contract(s).
Royalty payments are based on the success of the project. The more views, streams, sales, etc. that the project generates, the more those involved receive royalties [or passive income]. If the project fails, these royalties could be pennies or even nothing.
NFT royalties basically work the same way, but the contracts and royalty payments are digitally generated. NFT contracts live on the blockchain. Meaning that any creator can skip the pre-project contract, create their work, add it to the blockchain, and sell it with the condition that [if it’s successful], they receive a percentage of any future profits generated [from that project].
How are NFT Royalties Structured?
This passive income-generating model includes two main ingredients: NFT smart contracts and NFT royalties.
NFT Smart Contracts
An NFT smart contract is an agreement between the buyer and the seller of a digital asset (in this case, an NFT). An NFT (Non-Fungible Token) is a digital asset that represents an object or concept like art, music, a video, a certificate, or a key that gives the owner exclusive access to something. A smart contract doesn’t require lawyers or other third parties to get involved in creating or overseeing it.
To attach a smart contract to a piece of work, a creator takes their work and mints it. By minting it, the creator turns that work into an NFT, which adds it to the blockchain. The smart contract is now embedded [or attached] to that work indefinitely. Once it’s on the chain, a buyer can purchase it. By purchasing it, the buyer agrees to the terms of the smart contract. These terms may include royalties set by the creator in the event of any future resale of their work. We recommend a 10% royalty, but some creators opt for more.
NFT Royalties
Anytime the work is resold, the royalties set in the smart contract go to the creator. These royalties go straight into the creator’s digital wallet. The seller keeps the rest. Whether resale happens once, twice or a thousand times, the creator gets the royalties outlined in the smart contract.
NFT royalties can also be used to support fundraising efforts by adding charities or causes to payouts. Creators can allocate a portion or the total amount of their NFT royalties to their favorite charities. This allocation is set in the smart contract during the minting process.
Transparency in NFT Royalties
Each smart contract uses Distributed Ledger Technology (DLT). DLT is essentially an unalterable contract. This unalterable contract is decentralized, meaning that it is not controlled by a single entity; instead by a network of computers that validate its transactions. It also guarantees the authenticity of the NFT by maintaining a record of the original mint made by the creator.
The DLT establishes transparency for the creator, the buyer(s), and the reseller(s) throughout the lifecycle of the NFT. All parties involved in the first transaction and any subsequent transactions have access to who bought the NFT, who sold it, and who is currently holding it. Having access to this information is especially important for the creator who can see whenever their work changes hands and monitor their royalty payouts accordingly.
Royalty-Free NFTs
Not all creators opt for royalties when selling their NFTs, preferring to add their work to the blockchain for a one-time sale. By doing this, the creator hands over agency to the buyer to do whatever they want with the work. This is known as a royalty-free NFT sale. While this doesn’t generate passive income, this method may help creators who are just starting off, get some initial exposure and traction in the marketplace. For buyers, royalty-free NFTs are a win because they get the revenue from the total amount of the sale if and when they decide to resell the NFT.
Why Creators Should Use NFT Royalties
This one is simple — creators who make a one-time sale never get to piggyback off the future success of their work. If a creator sells their work for $2000, then three months later, their buyer flips that same work for $8000, their buyer keeps the entire profit from that new sale. But with an NFT smart contract in place, the creator of the work receives a royalty from that new sale. In this case, if the creator set the royalty at 10%, they see the equivalent of $800 [in crypto] deposited straight into their digital wallet [as that resale transaction takes place].
3 Ways to Earn Passive Income on NFTs
As a creator, selling your work is one way to earn passive income, but there are other ways to generate new revenue streams from NFTs [for both investors and creators]. These include:
Selling NFTs
Earning NFT royalties by selling your work is the most popular way to generate passive income. This is pretty straightforward. Make your NFT. Mint your NFT. Set your royalty percentage. Sell your NFT. Once your NFT sells, you receive the revenue from that sale. If your buyer resells your NFT, you receive a percentage from that new sale. And so on and so on.
Staking NFTs
Another way to earn NFT royalties is to stake an NFT. Staking means locking your NFT. A staked NFT cannot be bought, sold, or traded. The owner must hold onto them. In exchange for staking, the holder of the NFT receives regular cryptocurrency payouts. The only downside to staking is that the owner must hold the NFT to generate the passive income. If the price of that NFT falls, they may lose money. However, if they plan to hold onto that NFT anyway, staking is a good option to make money on it.
Renting Out NFTs
Forget being a property owner — generating cash from renting out NFTs is much easier [and cheaper]. Renting out NFTs is popular in gaming right now. One example would be when a player cannot afford to purchase an NFT required to participate in a play-to-earn game; they can rent that NFT to gain access and earn money.
This model will enter other industries — think fashion, furniture, and other things users will want in the metaverse. Renting out an NFT is simple — you have a smart contract that designates the NFT as a rentable asset. As the owner, you select the amount of time or rate that you will rent the NFT out for. Renters select the NFT, pay your rate, use it, then return it at the end of the rental period. NFT owners don’t need to search for renters either because the blockchain does this for them.
Conclusion
Returns on NFT royalties can add up quickly. For savvy investors, this passive income stream can easily surpass the revenue generated by other assets like stocks and real estate. Plus, NFT royalties come with little or no maintenance (unless you make a massive commitment to a high-ticket sale, like the artist, Beeple did in March 2021). NFTs are forging a path for all kinds of creators to cash in on their hard work.
Because the generosity that Phil Knight showed his designer, Carolyn Davidson, many moons ago is not the norm. The Knight/Davidson example is a unicorn in the creative space and one that has rarely [if ever] been replicated on that scale since. For traditional employers, agencies and investors, profiting off the creativity of others is one of the many ways that they grow their wealth. This has never been entirely fair. It’s time for creatives to level the playing field and benefit from the wealth accumulated from their work through royalties and passive income.
