Explained: Why NFT creators' reliance on royalties is unsustainable

Author: foobar

Source: substack

Royalty provides lucrative income for artists and creators. If you can make money from it, great! But royalties are not enforceable and thus not suitable for blockchains. This article will explain why reliance on royalties is unsustainable and how artists can consider more reliable monetization mechanisms.

My goal is not to negate royalties but to help understand what is sustainable and what is not. You should be proactive in aligning yourself with your medium rather than trying to fight it with all your might. Those creators who fully integrate crypto-native thinking through thoughtful mechanism design to create decentralized bearer assets will be rewarded handsomely.

Royalty distorts incentives

Take a closer look at the chart below. 6.9% creator royalties, hundreds of ETH withdrawn, millions poured into free pump minting. Bloot was a failed project that left collectors with nothing, while the team of creators still made money from the royalty profits.

Bloot is a free mint (free mint) project created by Beanie & co. The floor price is now below 0.01 ETH despite the transaction volume reaching 9000 ETH.

Rewards for creators should be based on the market value of collectibles rather than trading volume. This is a clear incentive distortion, paying creators based on volatility and turnover of holders, while they earn nothing from the faithful. This explicitly encourages low-quality pump-and-dump free minting, so it's no coincidence.

Traditional financial fiduciaries are paid proportionally based on profit rather than proportionally based on trading volume. When a collectible is sold for zero because the community learns about the ignoble details of the founding team, it's also not right for the ignominious founding team to earn additional secondary fees.

What is a better incentive alignment model? Creators should make money when collectors make money—simple as that. There are several options: (1) the creator holds a portion of the supply; (2) the creator earns a share of the sale profit, not the sale price; (3) the creator earns a rollover of the current project valuation via the Harberger tax percentage.

Royalties are not enforceable on-chain

NFT is a decentralized bearer asset. A bearer asset means that the person holding it has ownership and full control, and decentralization means that ownership/control cannot later be revoked by a third party. Enforcing royalties on-chain is impossible without introducing centralized control or breaking wallet-to-wallet transfers.

The first concept to understand is side payment. Compensatory payments are when Alice pretends to sell to Bob on-chain for a low price, and then sends additional payments separately. The true price cannot be verified in the transaction itself.

The second concept to understand is the wrapper contract. A wrapper NFT series points to an original NFT series and lets users mint wrapped versions of their NFTs by sending the original NFT into escrow. The wrapped NFT is then like ownership of the underlying object and can be freely traded without any restrictions that the original NFT creator might have programmed into the contract. See Wrapped Penguins , an experiment by the community against Cole before he sold ownership of the project.

Wrapped Penguins, a community revolt led by Vincent Van Dough against Cole's incompetent leadership

The third concept to understand is free wallet transfers. Rotating wallets are a fundamental aspect of recovery from hacking, financial health, key management, privacy, and personal security. While there have been some experiments, such as veTokens, to limit transfers, even this has fallen out of favor with transferable veNFTs. Some have proposed breaking this functionality by letting centralized administrators reverse transfers after the fact, adding KYC requirements to prove ownership of both wallets, or adding a fixed transfer fee. However, this cure is worse than the disease, and strikes at the heart of the crypto-spirit.

Expose several common misconceptions:

What if royalties were hardcoded into tokens? This usually just speaks to a lack of understanding of how ERC721 works. Transactions take place at the market contract level, using approvals and transfers.

What if there is a hardcoded fixed fee for token transfers? It's not a royalty, it's just a transfer tax. It breaks transfers from one personal wallet to another. It can be removed with a one-time transfer to the wrapper contract.

What if price oracle fees are hardcoded for token transfers? Running price oracles is hard and centralized. This breaks transfers from one personal wallet to another, which can be removed with a one-time transfer to the wrapper contract.

What if you blacklist marketplaces that don't respect your royalties? You cannot blacklist websites, you can only blacklist contract addresses. The market shifts contracts, and new ones are launched all the time. The cloned code appears at a different address. It's a constant game of cat and mouse. This requires permanent administrative control, and the risk of accidental or malicious loss of tokens.

What if an artist is allowed to reverse a token transfer for unpaid royalties? See below.

Centralization destroys the value proposition

Given arbitrary programmability, the only "solution" is to grant creators permanent administrative rights to blacklist addresses, burn tokens, or reverse transfers. For crypto-native collectors, this is an unacceptable trade-off with significant tail risks. DCinvestor says:

“Nor will I buy NFTs that contain code that may limit my ability to transfer. Not because I won’t pay royalties, but because I believe NFTs are the best permissionless, censorship-resistant bearer assets. Breaking this , they're not that interesting to me."

When people propose to "remove wallet-to-wallet transfers", "add a centralized blacklist", or "have creators burn tokens", they have destroyed the value proposition of the token itself. There is no way to enforce royalties while maintaining censorship resistance.

How Creators Can Sustain Profit

The reason to move away from reliance on mandatory royalties is not because they are morally wrong. As mentioned above, they just don’t fit the permissionless blockchain paradigm in the long run. You use different tools to paint on canvas than to carve marble. So, what tools are best for blockchain?

1) Liquidity owned by creators

Creators can keep a portion of the supply for themselves. This works for LarvaLabs, this works for 8liens and many other projects. With NFT financialization tools such as sudoswap , you can earn transaction fees without selling to fans.

2) Social leaderboards with voluntary payment of royalties

Even though royalties are not enforceable, many good players in the field expect to pay royalties. So making a public leaderboard with information on who volunteered to support artists can be gamified and encourage pro-social behaviour.

3) Junior sales after proving yourself

Also quite profitable, see LarvaLabs, YugaLabs, XCOPY, deekaymotion, etc.

4) Other works after proving yourself

Some say it's bad because it requires the artist to have fans. Unfortunately, this is a consequence of the attention economy, and building your own brand is a requirement for any monetization case. Unknown creators who can't sell their major work don't make any money from royalties.

5) Official endorsement of derivative works

In the crypto space, provenance is everything. So, how does the original creator of an idea get value from derivatives? Your words carry a lot of weight, and even an endorsement of a high-quality spinoff can prove quite lucrative.

6) Harberger tax

Harberger taxes are the crypto-native equivalent of royalties. Each NFT owner makes a personal assessment of the value of their tokens and periodically pays the creator a small percentage of it. Anyone can buy out tokens at any time at the current owner's valuation, preventing undervaluation. If you smooth out payments instead of discretizing them, this is compatible with free transfers, solves the price oracle problem, and is decentralized. There are some tricky UX questions about what it means to own a token, but one worth exploring.