Zero Royalty NFTs: A Paradigm Shift in the NFT Creator Economy or Just a Speculator’s Narrative?
Introduction
As one of Web3’s most polarising debates starts to heat up, we cannot help but notice a major shift in consumer behaviour as Peer-to-Peer (P2P) and Over-The-Counter (OTC) NFT marketplaces enable NFT buyers to opt out of paying creator royalties entirely. Following MagicEden’s recent move to make creator royalties optional for its traders, we see a significant divergence between the platform’s number of royalty-paying trades (orange line) versus the number of trades that do not honour creator royalties (blue line).
Following the growing competition of other marketplaces adopting optional royalties, MagicEden made the difficult decision and caved into the narrative. In its announcement tweet to make royalties optional, MagicEden noted that a growing consumer trend showed that more and more users choose to use optional royalty marketplaces to buy or sell their NFTs.
While creator royalties on Solana and Ethereum cannot yet be enforced at the smart contract level, we believe that this shift in market sentiment and consumer behaviour calls for greater innovation as eliminating royalties entirely is inherently unsustainable and detrimental to the $2.36 billion NFT creator economy we have built over the past years.
In this article, we explore how zero royalties came to be and dive deeper into the arguments for it, while also breaking down the problems it will create for all stakeholders. We also take a glimpse into the future and share our ideas and thoughts as to where we think the industry can move forward from here.
How did Zero Royalty NFTs come about?
For the longest time, NFT royalties have been a major selling point for independent artists and creators to hop onto the Web3 bandwagon to monetize the hard work and effort they put into their craft. However, one major flaw in the way the current NFT ecosystem infrastructure was built is that creator royalties are not hard-coded on a smart contract level, meaning that there is no way to enforce it through code.
While it is a common misconception that creator royalties are hard-coded, widely used NFT marketplaces like OpenSea and MagicEden typically operate on a goodwill basis as they choose to honour a creator’s desired percentage of royalties received per secondary sale. This means that creators are beholden to centralized third parties to execute these royalty payments, defeating the whole Web3 ethos of permissionlessness and trustlessness.
In July 2022, a brand new and innovative marketplace called SudoSwap entered the Ethereum NFT scene. Pioneering its open-source sudoAMM, a marketplace protocol for NFT liquidity and trading, it introduced a new way for users to trade NFTs in a highly flexible and gas-efficient manner, fully on-chain. The protocol enabled traders to trade instantaneously with liquidity pools instead of bidding on a marketplace like OpenSea. By bypassing creator royalties and offering 0% platform fees, the protocol managed to hit a peak of $2.35 million in a single trading day. In order to remain competitive, Ethereum-based NFT marketplace X2Y2 opted to make creator royalties optional and lower their platform fees to 0.5%.
Looking at Solana, MagicEden remained untouchable with its market dominance throughout the height of its NFT bull run. On most days, the platform made up over 80% of the NFT trading volume on Solana, significantly more than OpenSea and Solanart combined. In order to compete, a newer and lesser-known marketplace called Yawww decided to disrupt the status quo by rattling the hornet’s nest.
Within the past three months, the upstart NFT marketplace managed to garner significant market share within the Solana NFT ecosystem. Yawww placed second based on NFT volume traded with about $16.38 million against MagicEden’s whopping $271.95 million, not bad for a brand new NFT marketplace.
Yawww, the first OTC NFT marketplace on Solana marketed itself as the champion of the people with its tagline “Your NFTs, your choice.” The platform gave traders the power to choose how much creator royalties they would like to pay on their NFT listings, with 0% being the popular choice. With many NFT collections charging traders 8–12% creator royalties of every trade, Yawww quickly found its product-market fit as many traders shifted away from paying exorbitant creator royalty fees.
Although most NFTs on Solana use Metaplex’s NFT standard which has hard-coded royalties that can be enforced by the marketplaces that follow the standard, a simple P2P trade between two wallets is enough to bypass creator royalties entirely as illustrated below:
Though this shift received much criticism from the NFT creator community, many marketplaces followed suit to make creator royalties optional, following the demands of the shift in customer behaviour. Solanart took this a step further by permanently waiving its platform fees, allowing users to trade freely on its platform. Ethereum-based NFT marketplaces were not left out as well with platforms like LooksRare recently hopping on the bandwagon.
As an attempt to protect creators, MagicEden partnered with Coral Cube to introduce MetaShield, an anti-zero-royalty tool which creators can use to punish traders who evade paying royalties. Although initially strong champions of honouring creator royalties, DeGodsNFT, Coral Cube and MagicEden eventually caved and decided to follow the market’s demands as there was a clear need for innovation in the space.
Arguments for Zero Creator Royalties
In the most recent NFT bull market, paying 8–15% royalty fees on every NFT trade was the norm. However, with worsening global market conditions, overall NFT trade volumes across all major ecosystems have plummeted significantly. Compared to its all-time weekly high of $6.1 billion in January 2022, Ethereum’s weekly NFT trade volume is down more than 99% to $85.2 million. As a result, traders have become more reluctant to pay creator royalties and have opted for more cost-efficient alternatives.
Lower Trading Costs
While there is much to say about the knock-on effects of not honouring creator royalties, let us start by discussing the arguments one can make about this shift in market behaviour. The most obvious benefit is lower costs and fees for traders who actively trade NFTs. On top of eliminating creator royalties, many marketplaces have significantly reduced their marketplace fees to attract more trade volume. This gives speculative traders much better prices and profit margins as other overheads like creator royalties, platform fees and network gas fees become a non-factor.
This also lowers the barriers to entry for new NFT buyers who have weaker buying power. High creator royalties and marketplace fees may be a turn-off for first-time traders. As previously seen during Ethereum’s first NFT bull run, the network’s exorbitantly high gas fees caused many traders to seek cheaper alternatives, hence the user migration to Solana’s NFT ecosystem.
As a result of lower costs, a highly efficient trade environment allows for the innovation of market-making activities and high-frequency NFT trading to capture price arbitrage between NFT marketplaces. This results in more consistent NFT prices across marketplaces as highly popular NFT collections trade similarly to that of liquid fungible tokens.
Encourages Creators To Innovate
With the elimination of one revenue stream, creators are financially incentivized to come up with other means of monetization. This can be done through added NFT utility to introduce new revenue streams to the collection based on the brand or intellectual property. Pudgy Penguins does this very well by diversifying its revenue through its brand’s merchandise store.
Many proponents for zero royalty NFTs claim that NFT project owners who set high creator royalty fees are greedy and they get rich too quickly. Thus, they are not motivated to continue working on their project after its initial mint. This raises the bar for NFT projects to succeed as project owners will need to innovate to stand out from the crowd.
Enforcing Royalties Contradicts Permissionlessness
If you were to have self-custody over an NFT and have rights to its intellectual property, does the act of forcing you to pay creator royalties go against the very idea of permissionless infrastructure? A highly debatable topic that makes a valid argument.
For example, if you own the rights to the IP of your rare Bored Ape and commercialize it by featuring it in an advertisement, does the original creator have the right to receive a portion of the income generated from this interaction? Many argue that for NFTs to be key infrastructure to Web3, creator royalties need to be optional as forcing holders to pay contradicts the whole idea of permissionlessness.
Arguments Against Zero Creator Royalties
Although zero/optional creator royalties do bring some benefits as described above, we believe it causes a lot more problems than anything else. That being said, we do agree that there needs to be greater innovation in the space to ensure that independent artists and creators are rightfully taken care of. While DeGodsNFT initially did not support the zero royalties movement, they recognized that this issue needed to be addressed with a different approach.
Destroys A Revenue Stream For Creators
Royalties are the lifeblood of independent creators and NFT project teams. While initial mint sales can be significant, creator royalties can be seen as a more consistent revenue stream that creators can use for day-to-day expenses and overhead costs. Inversely, mint sales could be likened to company equity or fixed assets which can be used for larger investments or initiatives.
Oftentimes, creator royalties provide new NFT collections with a sustainable means to extend the project’s runway instead of utilizing their ‘equity’. Until sufficient utility for the NFT is created, or until the creator has developed another stream of revenue, the project will have no other source of income to meet short-term obligations like paying artists, community managers and web subscriptions.
In the recent months of bearish global market conditions coupled with the zero royalty narrative, many NFT projects had faced unfavourable consequences. Due to a lack of funding, Shadowy Super Coders had to shut down their free RPC nodes due to lack of funding, which were previously paid for by the royalties of its secondary NFT sales.
As more and more marketplaces enable traders to easily bypass creator royalties, project owners are financially incentivized to either increase their initial mint prices to generate more revenue in the beginning or mint more of the collection’s supply to the project’s treasury to sell over time as they would be personally invested in the future success of the project.
We believe eliminating creator royalties fundamentally harms the sustainability and growth of the NFT creator economy. Eliminating the revenue for the builders who create value for the NFT being traded is detrimental and counterintuitive to the underlying value of the NFT itself. Imagine profiting from someone else’s work and refusing to reward them for creating it in the first place.
Making royalties optional is a short-sighted business decision by marketplaces that puts the traders’ interests above its creators. If creators leave the platform due to struggles monetizing their work, the traders will follow them.
Scams, Rug Pulls and Wash Trading Galore
If incentives between project owners and traders are not aligned, many would-be founders may resort to rug-pulling their communities after the initial mint is completed. If long-term goals are not fairly compensated through creator royalties, the game theory for project owners would be to mint, rug, and then proceed to launch a new project under a different name, to rug again. This is a very dangerous precedent as scams become more common.
Wash trading becomes an even bigger problem once NFT trading becomes increasingly more competitive due to the lack of trading fees. Some marketplaces like Solanart take this to the next level and waive marketplace fees entirely. As pointed out by @TurntUpDylan, project owners can artificially inflate their project’s trade volume at virtually zero to low cost.
This effectively makes trade volume a meaningless metric as it can be so easily manipulated. This only encourages project owners to conduct wash trading activities for their NFT collections as trade volume helps their project achieve visibility on the marketplaces they are listed on.
Censorship and Policing
In an attempt to protect the creator economy, many project owners resort to punishing traders who do not honour royalties through the means of censoring, blacklisting and updating NFT’s metadata. MagicEden’s MetaShield was built exactly for this purpose. MetaShield gives creators the ability to track Solana NFTs listed with custom royalties and enables them to take the necessary actions to protect their business.
This harms the fundamental Web3 idea of being permissionless and censorship-resistant as project owners can explicitly authorise where you can trade your NFTs, or even punish traders by updating NFT metadata. Whilst a band-aid solution thus far, this solution is basically an eye for an eye, a tooth for a tooth. Where do we draw the line with regard to the idea of permissionlessness?
Where can we go from here?
In its current state, Web3 is still at a nascent stage where the majority of projects and applications are fundamentally driven by financial incentives. As creator royalties are not enforced on the smart contract level, market dynamics will follow the path of least resistance and are financially incentivized to bypass such fees.
“As the old saying goes, ‘show me the incentive and I’ll show you the outcome.” Dragonfly Capital’s Haseeb Qureshi describes this phenomenon as the “iron law of crypto — unless you have a mechanism to enforce something, competitive dynamics will cause it to get forked out.” Thus, the main point of contention here is how can we discourage, disincentivize or disallow users from circumventing creator royalties through smart contract wrapping.
Though the game of incentives is a difficult balancing act, we think that greater levels of innovation in the space need to occur to ensure that incentives between NFT creators, long-term collectors and traders are aligned. As of now, these incentives skew toward the benefit of the traders while creators and collectors get the short end of the stick. Many industry leaders are currently looking towards royalty enforcement, however, we believe this may lead to less innovation in the space, hampering the industry’s long-term growth.
In this segment, we dive deeper into the industry’s latest developments as to where we think the market is moving towards and also propose a potential solution for the industry to rethink how creators can monetize their work and social communities through NFTs.
Enforcing Creator Royalties On The Smart Contract Level
While it is the most obvious solution that one can think of, the enforcement of creator royalties could be seen as a knee-jerk reaction akin to fighting fire with fire. Much can be said about the decentralization and permissionlessness of this method but we believe that creators should have some say in dictating how their NFTs can be utilized.
Other than MagicEden and Coral Cube’s Metashield, many other teams on Solana are working to further develop a similar solution. In a blog post, Metaplex, the builders behind the original Solana NFT standard, revealed that they are creating the Metaplex Digital Asset Standard (DAS), a new token standard design which will enable NFT creators to configure how their NFT assets can be transferred to incentivize or influence honouring creator royalties, be it through updating metadata, flagging or enforcing payments. DeGod’s y00tsNFT will be the first Solana project to leverage this new standard.
In a similar vein, Cardinal, an NFT infrastructure protocol, collaborated with the Hyperspace NFT marketplace to pioneer the first live iteration for creator royalty enforcement. Instead of dishing out punishments to traders who do not honour royalties, Cardinal’s solution is a lot more elegant as it builds on top of Metaplex’s current standard to outright enforces royalties to be paid on all token transfers which involves a coincident movement of funds. The BBs NFT project is the first to launch with Cardinal’s royalty enforcement solution.
On newer up-and-coming blockchain ecosystems like Sui, Mysten Labs and OriginByte are looking to tackle this debate from the get-go. The team plans to implement a fully feature-rich NFT standard that allows creators to configure royalty conditions to the finest of details. These features include blacklisting malicious marketplaces, the ability to tax peer-to-peer transactions, and whitelisting allowed exchanges that creators wish to list their collections on. Creators can also choose to allow all marketplaces if they aren’t concerned about the royalties earned.
On that note, OpenSea has recently come out to reveal the launch of its new tool for on-chain enforcement of creator royalties for new collections. As the first iteration of this tool, the OpenSea Operator Filter Registry enables creators to effectively blacklist specific wrapper contracts from interacting with their NFTs. Essentially blocking NFTs from being traded on other competitor marketplaces which do not honour creator royalties. However, this reveal was faced with significant backlash from the community as NFT traders are forced to continue paying OpenSea’s 2.5% platform fees as other platforms are blacklisted.
With that said, we believe the key point here is that NFT creators should be able to ‘lay down the rules of the game’ and dictate how their work can be used, transferred or traded. We think that the freedom for a creator to have a say in how his/her work can be used is the bare minimum standard the industry should uphold. This enables creators to clearly define the boundaries, rights and functionalities of their NFTs right from the start, similar to how terms & conditions and legally-binding contracts are established in the real world.
Aligning Incentives
We believe that creator royalties are important for the sustainable development and growth of the NFT industry and the creator economy. However, aligning these incentives between creators, collectors, traders and marketplaces is no easy task. There are many ways to go about this but here are a few directions we think the industry can move towards.
Decreasing Creator Royalties
At the start of August 2022, the daily average percentage of royalties paid per NFT trade started to shoot up exponentially, with some days peaking as high as 19.34% royalties per trade. This eventually caused traders to seek alternative NFT marketplaces to avoid paying such high fees, inadvertently kickstarting the polarising debate.
In hindsight, paying upwards of 12–15% royalties per NFT trade is already a steep ask. From the data below, we can see a significant decline in the number of trades that continue to honour creator royalties, signifying a shift in NFT purchasing behaviour.
As a compromise, we believe a more reasonable creator fee would be around 7–8% which traders would not mind paying, as was the social norm among NFT projects prior to the controversial shift ain August 2022. Coupled with enforcing creator royalties through smart contracts, this option could be a reasonable middle-ground rather than have one of two extremes.
Building a Loyal Community
However, if the enforcement of creator royalties is ineffective, @beeple points out that creators will need to build a collector base that would want to honour these royalties. Differentiating themselves from traders, collectors have very different needs, wants and motivations for owning an NFT.
Traders generally purchase or mint an NFT with the intention of making a financial gain. Collectors purchase NFTs for the same reasons a fine-art collector would. They would much rather own an NFT because they genuinely like the art, find value in the meaning it holds, or they want to support the creator of the art. As elegantly put by @nonieengel, we should not generalize NFT purchasers as traders who are not patrons or collectors. Traders would not care about supporting the creator in the first place.
In order to build a loyal community, creators should bring value to their long-term collectors to incentivize paying royalties instead of earning it through enforcement. Depending on what type of NFT it is, be it a social community, fine art, metaverse or gaming NFT, each can find its own ways to bring value to its community. For example, social profile picture NFT projects can enable collectors to monetize their NFT through advertising and IP rights. For fine art NFTs, collectors of 1-of-1 pieces could get private access to the artist’s private art exhibitions and events.
At the end of the day, the most loyal community members would want the creator to grow. Thus, as a creator, one needs to build their own brand and business by introducing other ways of monetization apart from mint sales and creator royalties. NFT projects can create value in many different ways, be it through selling branded merchandise, or by providing limited access to a certain service. Collectors need a reason to support a creator’s work, and building a business around your NFT incentivizes them to support you as a creator.
Marketplace Fee Sharing with Creators
From a creator’s perspective, if a marketplace does not honour your collection’s royalties, you would be less inclined to collaborate with the platform. Unchained’s Laura Shin puts it simply “Income is fungible, art is unique.” Great creators are hard to come by, thus in order for marketplaces to succeed, they need to take care of their creators.
Despite making creator royalties optional, LooksRare offers to direct 25% of its platform’s fees to support its creators. Whether or not this is substantial enough for creators, this is definitely a step in the right direction. While we believe that marketplaces are not obligated to share their platform’s fees with its creators, we think it is in their best interest to do so to be the marketplace partner of choice.
With that said, we think the sharing of platform fees with creators may not be sustainable as market dynamics continue to shift toward lower fees. Coupled with increased competition between marketplaces, we believe this is a short-term solution that may have varied results.
Token Incentives for Honouring Royalties
If one cannot solve the debate through other means, do it Web3-style and slap a token incentive on it. The newest kid on the block, the Blur NFT marketplace, takes a different yet familiar approach to the problem. Instead of forcing traders to pay royalty fees, they instead incentivize traders through its $BLUR token airdrop. Depending on how its tokenomics is designed and how its value is accrued, this solution may be a viable option.
However, one consideration is that the token should have proper value accrual mechanisms in place to incentivize users to want to hold the token. This enables the project to balance its token emissions to prevent excessive price dumping and what happened to most of the first generation of DeFi-related tokens.
We propose Harberger Tax: A new economic policy for NFTs
As the main point of contention is that creator royalties are currently not enforceable on the smart contract level and can easily be circumvented using wrapper contracts through P2P/OTC NFT marketplaces which do not honour royalties, we propose a new way for creators to elegantly monetize their NFTs and communities to push the space forward. We believe that Harberger Tax has the potential to reshape the way we think about NFTs and open up a plethora of opportunities for creators and collectors alike.
Highlighted in the piece “Property Is Only Another Name for Monopoly” by Eric A. Posner and E. Glen Weyl, Harberger Tax is a radical economic policy proposed by Arnold Harberger that aims to challenge the economic status quo, to strike a balance between private ownership and commons ownership shared by all, in an attempt to increase the general welfare of society.
The tax is based on the idea that economic rent is an unproductive use of resources and should be taxed in order to discourage its collection. The tax is also intended to encourage the efficient use of resources by making it more expensive to hold on to unproductive assets.
The Harberger Tax introduces two main ideas:
- The value of assets is self-assessed by its owners, who then pay taxes on that self-assessed value.
- Anyone at any given time can purchase that asset from the owner at that self-assessed price, thus taking ownership of the asset. The new owner will then set a new self-assessed price.
In that sense, an asset owner is incentivized to set a low enough price to minimize how much tax he has to pay, while concurrently setting a high enough price to discourage anyone from purchasing it away. In this system, asset owners cannot set unreasonably high prices nor turn down valid offers. This effectively allows the market to price assets more efficiently as owners are financially incentivized to value an asset at the price they are willing to pay to retain ownership of it.
With regard to NFTs, co-founder of Ethereum, Vitalik Buterin, previously proposed this idea as a solution in anticipation of this flaw in the way NFTs are architecturally designed. He provides three main flaws why creator royalties cannot be guaranteed:
- Transfer fees are trivially circumventable with wrapper contracts.
- We want to move to smart contract wallets (eg. multi-sig wallets), and smart contract wallets themselves are effectively sellable wrapper contracts.
- There are legitimate (non-sale) reasons to transfer your asset to another wallet.
In the context of implementing Harberger Tax in Web3, NFT owners set a price they are content to sell at, while paying a small percentage of that price to the NFT’s original creator at regular intervals. At the same time, all NFTs are perpetually on auction so that anyone can purchase the NFT at the self-assessed value at any given time.
As explained by @ArthurB, this system is easy to enforce as there are no ways to evade it if implemented correctly, “There are no hedge cases, no need to judge intent, no need to define what constitutes evading the rule. It works because it strikes at something that is ontologically meaningful. Limit orders are meaningful, trades aren’t.”
As a radical idea, mileage in social and cultural acceptance may be varied as the idea of paying taxes on the assets you own may seem a bit far-fetched and might inversely disincentivize collectors and traders from purchasing said NFTs in the first place. However, one consideration is that the NFT creator should be able to adopt the Harberger Tax concept but apply his/her own configurations to it based on what type of NFT project it is, effectively giving the creator freedom of choice.
Though an untested economic policy, we believe this concept is worth experimenting with, harnessing the power of blockchain ledgers and smart contracts. Stay tuned for our next piece where we will dive deeper into how Harberger Tax can be implemented through NFTs. If you are currently building an NFT project and are interested in this concept we are exploring, do reach out to us via our Twitter at @TheSpartanLabs.
Conclusion
While both sides make very strong arguments in this polarising debate, we are certain that both parties can agree that this calls for greater levels of innovation in the space. As the market increasingly trends toward zero or optional royalties, we cannot expect the social norm to regress back to how it was a year ago. As creator royalties were not enforceable to begin with, it is highly unlikely to ever see this being the norm again.
Marketplaces that treat creators as second-class citizens in the metaverse will soon realize that bad short-term business decisions to gain market share will lead to their eventual demise as creators and their communities work with those who treat them as equals. Once creators leave, their diehard communities and raving fans will follow. Offering creators a cut of platform fees or token airdrops to incentivize paying royalties is a step in the right direction.
Although we agree that creators should have some form of control over how their NFTs can be used and transferred, we believe that enforcing creator royalties through punishment will open another can of worms as things can get ugly very fast. Censorship and policing defeats the purpose of why we are here in the first place as the ideals of a permissionless and immutable decentralized digital economy should be held paramount. With that said, we believe creators should have the freedom to determine the rules and boundaries of how their NFT collection can be transferred and used from the beginning.
While zero royalty NFTs and optional royalties create more problems than anything else, it raises many important questions that we need to solve in order to mature as an industry and reach widespread acceptance and mainstream adoption. Creators should opt for creating value through other forms of monetization rather than relying on royalties through aggressive methods like enforcement.
We believe creators and builders alike need to be supported for this nascent industry to succeed. Thus for our next piece, we will explore how Harberger Taxes can be implemented to empower creators and rethink the entire NFT creator economy, stay tuned for more.
Disclaimer: This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment. It should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice or investment recommendations. This post reflects the current opinions of the authors and is not made on behalf of Spartan Labs or its affiliates and does not necessarily reflect the opinions of Spartan Labs, its affiliates or individuals associated with Spartan Labs. The opinions reflected herein are subject to change without being updated.
About the Author
This is research report authored by Gabriel Foo of Spartan Labs.
Spartan Labs is a venture studio under Spartan Group that advises and co-builds projects with the most optimal and effective design at launch and beyond by providing tokenomics design and project implementation. Spartan Labs also produces research reports and articles that are aimed at helping web3 users gain insightful perspectives with regard to the developments and issues within the space.
