Aug 31, 2022
NFT Royalties: How do they work?
NFTs are, without a doubt, one of the most polarizing innovations in recent years. Some consider them to be the future of collectibles and a revolution just waiting to happen, while others think they’re overblown, overhyped, and that most will fail.
The truth is, they’re likely a bit of both. Some collections will undoubtedly stamp their name into the history books as truly disruptive creations, whereas the majority will eventually fall into obscurity.
Despite this, few can deny that NFTs have the potential to drastically change the way royalties are tracked, distributed, audited, and verified. Thanks to the use of blockchain and smart contract technology, it might not be long until royalties become part-and-parcel of interacting and transacting online.
But what are NFT royalties, exactly?
What Are NFT Royalties?
Similar to those seen in the film and music industry, royalties in the NFT space are a type of payment made to a person or company for the ongoing use of their assets.
Most commonly, they take the form of a commission when an NFT is sold or resold. This commission is directed to the NFT creator or another rights holder. In some cases, royalties are automatically collected by the underlying token contract when an NFT is sold on a decentralized marketplace, whereas in other times the royalties are independently withheld by the marketplace for later disbursement.
For example, if an NFT with a 10% royalty associated with it sells for 20 ETH, then 2 ETH (10% of 20) will be directed to the wallet of the NFT creator, whereas the remaining 18 ETH will go to the secondary market seller.
This solution allows NFT creators, artists, and brands to generate a perpetual source of revenue from their creations, which they can then use to develop their products and potentially provide utility and additional value to holders.
The exact percentage charged as royalty can vary by NFT and NFT collection, but 5–10% of the sale price is generally considered to be standard. For higher volume NFT collections, a smaller royalty fee of around 2.5% is commonplace.
It should be noted that not all NFTs have a royalty feature, this often needs to be coded in from the start and is generally associated with newer NFT collections.
Some of the most popular collections with a royalty mechanic include:
- Azuki: 5% fee on secondary sales distributed to Chiru Labs.
- Doodles: 5% royalty fee, half of which goes to the community treasury (the Doodlebank).
- Bored Ape Yacht Club (BAYC): 2.5% secondary sale fee distributed to Yuga Labs.
- Meebits: 5% royalty fee distributed to Yuga Labs.
By simply multiplying the on-chain trading volume for popular NFT collections by their royalty fee, it’s not difficult to see how royalty fees can quickly stack up to become an impressive passive income stream for individual artists or a semi-passive revenue stream for firms.
Indeed, according to recent data from Nansen, Yuga Labs — the firm behind several popular NFT collections — earned almost $148 million in royalties across 4 collections.
How Are Royalties Added to NFTs?
As we previously touched on, NFT royalties ensure that the original creator (and sometimes the original buyer) get a fraction of the sale price each time the NFT is sold on a marketplace.
But how does this system actually work? Well, it is powered by novel smart contract functionality that is used to detect when an NFT is sold and for how much. The requisite royalty percentage is then deducted from the net sale price, and redirected to the royalty interest holder, with the remaining distributed to the NFT seller as usual.
This mechanism typically only works when the NFT is sold on a decentralized NFT marketplace since this allows the NFT token contract to easily track when an NFT has changed hands as part of a sale. This usually only applies to specific NFT marketplaces, like OpenSea or Rarible.
There are several NFT standards capable of supporting royalties. These include both ERC-721 and ERC-1155, and many modern NFT collections implement the EIP-2891 royalties standard to help ensure royalties are honored across a wide range of secondary marketplaces.
Although these standards are designed for Ethereum smart contracts, similar royalty functionality exists on other NFT-capable blockchains, including Flow, BNB Chain, Solana, and Tezos.
It’s usually a simple task to determine the royalty percentage associated with a particular NFT or NFT collection. Platforms like Icy.tools can be used to see a collection’s royalty fee, whereas most marketplaces will also detail any applicable royalty fees.
This percentage can then be converted into a fraction and multiplied by the sale price to determine the royalty fee, e.g.
0.05 (royalty commission) * 30 ETH (sale price) = 1.5 ETH (royalty fee).
In some cases, royalty fees are applied to all secondary market sales that occur after minting, whereas in other cases this only applies for a limited period — such as for a fixed period of time or fixed quantity of sales. Royalties are generally specified when the collection is created. But in rarer cases, they are added at a later date.
How Some NFT Marketplaces Avoid Royalties
As you might expect, some marketplaces consider NFT royalties to be a direct competition to their revenue stream. After all, if an NFT collection already has a flat 5% royalty fee and a marketplace has a 2.5% sale fee, the total fee paid by the seller is 7.5% — which can be considered a deterrent to trading.
Newer platforms like Sudoswap do not honor royalty fees, arguing that royalty fees are “inefficient” since buyers often need to see their assets appreciate by at least 10% just to break even on a secondary sale.
Instead, Sudoswap applies a simple 0.5% fee to all trades and ignores any smart contract-based royalty agreements. Some believe that this might help to create a more healthy trading economy, while others believe that NFT creators should be entitled to a cut of the pie should their collections achieve success, and that without on-chain royalties, NFT mints will inevitably become more expensive or other less transparent monetization systems will grow in popularity.
EIP-2981 was designed to help address this challenge, by ensuring the royalty mechanism can be applied to secondary market sales conducted on a wide variety of NFT marketplaces.
According to the full Ethereum Improvement Proposal (EIP), the new standard will allow all marketplaces to retrieve royalty payment information for NFTs, allowing them to easily implement support for royalties. That said, even this solution will be unable to enforce royalty payments for simple OTC trades or platforms that opt to ignore the royalty.
Centralized marketplaces, on the other hand, can manually honor the royalty terms of each NFT collection. Some of these adhere to them completely, some cap the royalty rates, while others ignore them entirely. Many centralized exchanges use Manifold.xyz’s royalty registry to determine the correct royalty fee to hold back and distribute to creators.
With the rapid expansion of Web3, the question of whether or not to pay NFT royalties is likely to have reverberations in the blossoming decentralized Web3 landscape — leading to a schism that will see some Web3 apps adopt royalty-like mechanics and others reject them.
Nonetheless, whichever side of the fence you currently sit on, you can expect to see royalty mechanics cropping up a variety of Web3 sectors, whether that be the metaverse, decentralized finance (DeFi), decentralized storage and hosting networks, blockchain-enabled games, or something entirely novel. Anything that has user or brand-generated content stands to potentially integrate this new revenue mechanism.
Are NFT Marketplaces Secure?
Just like traditional cryptocurrency exchanges, NFT marketplaces come in two main varieties: centralized and decentralized. Some of the most popular platforms, including OpenSea and Binance NFT are currently partially or completely centralized, meaning listings are not permissionless, NFTs aren’t automatically transacted on-chain using smart contracts, and users do not control their private keys.
Decentralized NFT marketplaces, on the other hand, typically offer permissionless access and listings, allow users to control their private and hold custody of their own assets, and carry out trades on-chain — ensuring royalty mechanisms are (usually) honored.
Given that they operate differently, centralized and decentralized NFT marketplaces can vary quite considerably in their security and the potential attack vectors they might be vulnerable to. For example, centralized NFT marketplaces are inherently subject to custody risk. If the centralized wallet is breached, anybody trusting the exchange with custody of their assets could find themselves out of pocket.
This risk isn’t present on decentralized platforms, but there are instead smart contract risks — which could see attackers exploit bugs in the smart contract in order to cheat the system in some way. This was seen back in January 2022, when an unknown attacker exploited a bug in OpenSea’s smart contracts to snag rare NFTs for huge discounts.
As of yet, a major centralized NFT marketplace hasn’t been hacked. However, given that centralized exchange hacks are relatively commonplace (with several occurring each year), it’s likely just a matter of time until this uninterrupted stretch is broken.
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About Master Ventures
Master Ventures is a blockchain-focused venture studio helping to build the next generation of blockchain-based Web 3.0 system innovations within the crypto industry. Launched in 2018 by Founder and CEO Kyle Chassé, the company’s ethos can best be summarized in the acronym #BeBOLD: Benevolent, Open, Love, Decentralized.
Master Ventures co-creates with entrepreneurs and businesses worldwide to turn the best ideas into innovative and disruptive products. They do this by investing as strategic partners through offering advisory services to the projects they believe in. To date, Master Ventures has invested in over 40 crypto projects, including the likes of Kraken, Coinbase, Bitfinex, Reef, DAO Maker, Mantra DAO, Thorchain, and Elrond.
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