NFT Royalties: how they work and why they should be on-chain
Non-fungible tokens, short NFTs, have seen broad adoption throughout 2022, with major brands like Instagram enabling artists to sell them through the platform and Starbucks issuing a loyalty program based on them.
One of the most significant selling points of NFTs has always been the sovereignty it would provide buyers with and their potential to empower artists who, in traditional structures, have not been paid fairly. DJ Steve Aoki stated that he had made more money from his music NFTs than from millions of plays of his songs on Spotify.
The tool that facilitates earnings for creators in the NFT space are royalties.
What are royalties?
Royalties are a percentage of each sale sent to the original creator of an NFT whenever the work is sold on the secondary market. This starkly contrasts with web2 platforms creators use to monetize, where they are paid little to nothing for views and clicks and often rely on ad revenue. When minting an NFT, creators can specify a percentage of royalty they want to earn, which is usually set somewhere between 2–10%. This percentage is then taken from the sale price at every sale. Consequently, the ones paying the royalties aren’t the buyers but sellers, similar to the commission model in real estate transactions.
Royalties offer creators a way to obtain recurring revenue from their works with every sale without intermediaries aiding transactions. All payments are automated, and returns are transferred to the artists’ wallets with every secondary sale. It’s a very attractive proposition for artists as it enables them to benefit from a future appreciation of their works. If an artist initially sold their artwork for $100 and specified a royalty of 10%, they might just receive $10 on the first sale. But if demand increases and their works start trading for $1000, now they obtain $100 on each sale.
How do royalties work?
Ethereum remains the biggest market for NFTs, with many blue-chip collections calling the smart contract platform their home. However, few realize that royalties are not programmed at the smart contract level. When minting an NFT on Ethereum, creators will use a smart contract that defines all the metadata of the NFT and creates the actual NFT. The most common way to make NFTs as an artist without relying on smart contract developers is by using the interface of marketplaces like Opensea. These provide a simple UX to mint and define royalties for each NFT.
These royalties are not written in the smart contract because it’s impossible to use the transferNFT function to calculate royalty payments. That’s because to do so; the contract would have to determine if someone is transferring an NFT to a different wallet or making an actual sale. The only way to track that information would be to rely on a centralized entity with the power to revoke features as required. Introducing such an entity undermines self-sovereignty and goes against the notion of decentralization.
On the other hand, if one enforced the royalties at the contract level, it’d be bad UX because users would have to pay royalties even when transferring between their wallets.
Token Standards
On Ethereum and other smart contract platforms, NFTs are defined using token standards. The most common standard for NFTs is ERC-721, but recently a new standard was proposed to bring on-chain transactions and royalties together. However, the challenge with token standards is that they are easy to circumvent.
All it takes is a wrapper that acts like a box covering up what’s inside. Using these wrappers, traders can still trade without paying royalties regardless of the underlying token standard.
The role of marketplaces
Since royalties can’t be enforced on the smart contract level nor through standards, the entities enforcing them are NFT marketplaces. It’s more social enforcement than at the code level, and recently, marketplaces’ support for royalties has stood on shaky grounds.
Abandoning royalties?
When trading volumes and NFT values started dropping in 2022, traders became more sensitive to pricing, and competition among marketplaces heated up. In July, Sudoswap launched a marketplace removing all royalties and reducing platform fees to 0.05%. Another marketplace to launch around the same time was X2&2 which similarly eschewed royalties using wrappers.
Shortly after, Magic Eden, the biggest marketplace in the Solana NFT ecosystem, made all its royalties optional, leaving it up to users if they wanted to pay royalties. Similarly, Looksrare moved away from royalties, but in a gesture aimed at showcasing their support for artists, decided to allocate 25% of their platform fees to creators.
The market leader OpenSea moved in the opposite direction by providing creators with a tool that allows them to enforce royalties in new collections and blacklist marketplaces that don’t require royalty payments. All these moves have sparked a bigger debate about how royalties should be handled.
One positive aspect of that debate is that NFT projects have started considering different business models that do not rely on recurring royalty payments to maintain revenue. Among the options are subscription models and various ways to monetize the underlying IP. Additionally, some advocate for an increase in off-chain utility, where NFTs would work more similarly to memberships that provide holders with unique perks.
Nevertheless, the underlying problem is only solved if it becomes possible to monitor royalties on-chain.
Bringing royalties on-chain
Ternoa takes a different approach to NFTs. Instead of relying on smart contracts, NFTs are directly baked into the chain. Our goal is to empower anyone to build their own NFT project, regardless of whether they are a web3 developer or not.
To ensure interoperability, Ternoa is using the Substrate Framework, which also forms the foundation of Polkadot. A crucial element in Substrate are so-called pallets: pieces of software fulfilling specific functions. You can imagine them similar to lego blocks. One pallet might define a simple token, another one governance, and yet a third of how people can vote on a chain. By combining pallets, developers can create their very own chains. And by defining pallets, they can offer others the functionalities associated with them.
With Ternoa, we’ve developed pallets that fulfill advanced NFT needs. When creating an NFT on Ternoa, creators set their royalties when minting. Once the NFT is sold, they will automatically receive their royalty payment.
Unlike with smart contracts on Ethereum, on Ternoa, transfer, and sale differ. You won’t be charged royalties when you just want to transfer the NFT you own from one wallet to another.
To sell it, you must list the NFT, which is a separate function. A simple yet elegant solution to ensure that creators continue benefiting from their artwork being sold without creating a clunky UX. All of this happens directly on-chain and is enforced through the marketplace pallets which you use whenever you list an NFT.
Ternoa NFTs provide complete visibility, transparency, and immutability by bringing royalties on-chain.
Only when NFT royalties are happening and enforced on-chain creators can rest assured that they will continue receiving them.
But don’t just take our word for it. Try it!
Getting started
If you’re a developer and know JavaScript, the Ternoa SDK is the best way to start creating your first NFTs. Follow our guide here to get started, and with just a few lines of code, you can mint your first NFT and set royalties that will be paid on each sale.
