Non-fungible tokens (NFTs) have taken the art and collectibles world by storm. As the market for digital art and assets grows exponentially, conversations around creator incentives and compensation models have moved front and center.
NFT royalties are emerging as a popular mechanism to reward artists. But they also have downsides. Moreover, Bitcoin‘s ordinal inscriptions take a different approach that doesn‘t directly enable royalties.
This raises important questions around how to sustainably fund creators in Web3. I explore this complex dynamic between artists, collectors, incentives and blockchain technologies.
What Exactly Are NFT Royalties?
NFT royalties allow creators to earn a percentage of secondary sales when their NFTs are sold across different marketplaces. It serves as a form of continuous compensation tied to the ongoing value of their work.
For example, if a digital artwork is resold for a higher price, the original artist gets a cut of the profit in the form of royalties.
Royalties are configured during NFT minting and encoded within smart contracts on the blockchain. When the NFT is sold, the smart contract automatically executes to pay the creator the predefined royalty amount.
Royalty rates typically range from 5-15%, with an average of 10%.
For instance, on SuperRare, each secondary sale triggers a 10% royalty payment to the artist. On Foundation it‘s 10% for creators and 5% for the platform.
Royalty standards like ERC-2981 on Ethereum help incorporate royalties across NFTs systematically. This interoperability enables royalties across marketplaces and secondary sales.
How Exactly Do NFT Royalties Work Under the Hood?
NFT royalties are enabled through smart contracts on blockchain networks like Ethereum, Solana and Flow.
Smart contracts are self-executing programs that run automatically when predefined conditions are met.
For NFT royalties, a smart contract is created when minting the NFT. This contract contains instructions like:
If NFT #99 is sold:
Pay 10% of the sale price to CreatorWalletAddress
Pay 2% of the sale price to MarketplaceWalletAddressWhen this NFT is sold on a compatible NFT marketplace, the smart contract automatically executes. It calculates the royalty percentages based on the sale price, and transfers these amounts to the predetermined wallets.
This ensures creators receive timely compensation without any manual interventions or centralized intermediaries. The entire royalty calculation and payment is handled transparently on-chain through self-executing smart contracts.
In 2021 alone, over $300 million in royalties were paid out to artists from NFT sales, marking exponential growth.
Why Are Royalties Important for NFT Creators?
NFT royalties present several advantages for artists and the broader ecosystem:
1. Continuous Revenue Stream for Creators
Royalties provide creators with a consistent passive income source tied to their work‘s ongoing value. As their work appreciates with the market over time, they continue earning in proportion to its worth.
Mike Winkelmann, better known as Beeple, has earned over $20 million in royalty payments from over $100 million in secondary sales of his iconic NFT collection.
This demonstrates the staggering earning potential of NFT royalties for successful creators.
2. More Equitable Distribution of Value
By aligning incentives, NFT royalties help distribute value more fairly between creators, collectors, investors and marketplaces.
Platforms like OpenSea charge 2.5% fees. Collectors may earn from flipping the NFTs. Meanwhile, creators earn royalties from secondary trades. Each player is incentivized to act in ways that grow the broader NFT space.
3. Incentivizes Ongoing Creator Involvement
Since royalties are tied to the market value of their work, creators are incentivized to continue nurturing their community, promoting their collections and expanding their brand. Their active engagement and reputation can directly impact royalty revenue.
For collectors, the creator‘s involvement adds intangible value to the NFT assets they own.
Bored Ape Yacht Club is a prime example of creators engaging with owners to build an entire brand that adds value beyond just the JPEGs.
4. Helps Build Vibrant NFT Communities
Thriving marketplaces with engaged creator communities help drive mainstream adoption of NFTs and Metaverse assets.
As the market grows, so does the overall value. Even owners whose NFTs aren‘t directly sold can benefit from holding rare assets in a popular market.
5. Rewards Creation of Original Works
For creators, royalties incentivize producing unique digital assets with provable scarcity that stand out from the crowd. These rare and scarce works are likely to be valued and traded more on the market.
Knowing this, a rational creator would invest effort into developing truly distinctive NFT artwork rather than mass producing cookie-cutter copies.
Key Drawbacks of NFT Royalties to Consider
Despite their advantages, NFT royalties also come with some limitations to be aware of:
1. Royalty Terms Vary Across Platforms
While royalty rates generally range from 5-15%, there is no universal standard enforced across all NFT marketplaces currently.
For example, SuperRare uses 10% royalty fees while Binance Marketplace has an adjustable range of 0-10% for royalties.
This variability means that artists and collectors need to do research to avoid getting surprised. If they are not familiar with the specifics of the royalty terms, they risk losing out on expected revenue.
2. Technical and Platform Limitations
Since royalties rely on smart contracts, they need to be supported on both the NFT origination platform and the marketplace where sales occur.
Issues can crop up if transferring an NFT across blockchains, like from Ethereum to Solana, if the destination chain does not support the royalty standards used where it was minted.
Similarly, within a single blockchain, certain marketplaces may not have integrated royalty smart contracts. If an NFT is created on one platform but sold on another that doesn‘t enforce royalties, it leads to lost revenue for creators.
3. Tax Implications Can Be Challenging
Depending on jurisdiction, all income from NFT sales including royalties may be considered capital gains and could be subject to taxes.
This complicates tax reporting and collection for creators, who need to account for both primary sales and unpredictable future royalty amounts in their filings.
4. Risk of Smart Contract Exploits
While rare, there have been instances where bugs or vulnerabilities in the smart contracts governing NFTs were exploited by hackers to redirect royalty payments.
For example, MEV bots have stolen royalty revenue worth thousands of dollars in some cases by front running transactions. These technical risks threaten royalty income.
5. Possibility of Price Manipulation
Illiquid NFT markets are susceptible to price manipulation via wash trading. A small group of actors could artificially inflate prices and trade an NFT between themselves to game royalty payouts.
This distorted valuation could unjustly skew the royalty percentages sent to creators, leading to distrust.
6. Controversial Content for Profit
A major critique of NFTs is creators selling provocative or plagiarised art simply to profit from royalties. For example, some artists have called out explicit racist NFT collections like The 1937 Collection, now removed from OpenSea.
While not universally true, this concern looms over the royalty model, which incentivizes anything that sells irrespective of values.
7. Reduces Liquidity
NFT proponents argue that frictionless, global exchange of digital assets is a key value proposition. However, royalties can reduce liquidity by adding extra steps into transactions.
This fundamental friction between unfettered exchange and creator revenue limits fluidity in trades.
Why Don‘t Bitcoin Ordinals Natively Support Royalties?
Unlike NFT networks like Ethereum, Bitcoin was intentionally not designed for complex smart contracts required for royalties. Here‘s why they are incompatible:
Limited Scripting Language
Bitcoin uses a simplistic scripting language with limited functionality compared to Solidity on Ethereum. This makes sophisticated smart contracts difficult.
Scalability Challenges
Bitcoin‘s throughput is ~7 transactions per second with slower block times. This low capacity cannot efficiently handle high volumes of micro-transactions like royalty payouts.
Intentional Design Tradeoffs
Bitcoin‘s protocols optimize for decentralization, security and censorship resistance over advanced features like DeFi or NFTs.
While some envision upgrades like RGB protocol to enable smart contracts on Bitcoin, its current limitations preclude native royalties.
Alternatives for Compensating Creators of Bitcoin Ordinals
Though they don‘t enable direct royalties, there are ways to support creators on Bitcoin:
- Direct patronage: Fans can use the Lightning Network, tips or donations to directly reward creators. Similar to patronizing artists through platforms like Patreon.
- Exclusive content/merch: Creators can sell bonus digital content, merch, live sessions, etc. to engaged fans and collectors willing to pay a premium.
- Third-party licensing/cooperatives: Collectives like Ujo Music use Bitcoin to pay licensing fees to artists. Similar models could allow ordinal creators to earn licensing revenues.
- Advertising revenues: Creators with large followings and traffic to their ordinal profile pages can earn revenues from advertisements.
- Crowdfunding: Fans crowdfund ordinal projects via Bitcoin, especially sequels to existing collections they want to see.
While not as seamless as automated royalties, Bitcoin incentivizes creators to directly engage with their community and build creative monetization models. The open nature offers flexibility limited only by imagination.
Key Differences Between Ordinals and NFTs
To summarize, here are some of the key differences between Bitcoin ordinals and NFTs:
- Blockchain: Ordinals use the Bitcoin blockchain while NFTs are typically on Ethereum
- Native Royalties: NFTs support on-chain royalties, ordinals don‘t
- Cost: Minting ordinals is essentially free compared to NFT gas fees
- Speed: Bitcoin transactions are slower than most NFT chains
- Scripting: Bitcoin has a basic scripting language unlike Ethereum‘s Solidity
- Adoption: NFTs are more widely used while ordinals are still finding niches
- Regulation: NFT markets are largely unregulated while Bitcoin is prohibited in some nations
These differences lead to divergent creator incentives, designs and values between the two models. But we may see more convergence with solutions like Stacks bringing NFT functionality onto Bitcoin rails.
Sustainable Models to Reward Digital Creators
NFT royalty payouts provide clear and automated incentives for artists to keep creating original works. However, the model is not without flaws.
Bitcoin‘s ordinal inscriptions take a back-to-basics ethos focused on decentralization and immutability rather than complex logic. This provides certain core benefits but precludes direct royalties.
There are merits to both approaches and room for creative hybrid models like those emerging on Stacks.
As blockchain technology evolves, artists, collectors, entrepreneurs and developers all have roles to play in shaping sustainable frameworks to fund digital creators. Any model that enriches our shared metaverse through empowering artists and collectors has tremendous value to contribute.