The NFT Royalty Dispute: The Extreme Tug-of-War Behind $1.8 Billion

Original Title: 《NFT Royalties: The $1.8bn Question》

Authors: Sal Qadir, Gabe Parker, Galaxy Research Partners and Researchers

Compiled by: Paimon, Foresight News

Over $1.8 billion in royalties have been paid to creators of Ethereum-based NFT collections across the internet. Additionally, on OpenSea, the platform that has paid the most royalties to creators so far, the average royalty percentage paid to creators has doubled over the past year—from 3% to 6%. Major NFT brands, including traditional players and cryptocurrency-native organizations, have generated hundreds of millions of dollars in revenue from royalties derived from secondary sales.

In fact, just 10 entities account for 27% of all royalty revenue, while 482 NFT series account for 80% of all royalty revenue to date. However, there has recently been a backlash against the royalty model within the broader cryptocurrency community, with critics arguing that "royalties" threaten the value proposition that NFTs were founded upon. The reality is that royalties are not a permanent original product inherited on the blockchain in the crypto world.

Research Methodology

All data, including the $1.8 billion royalty revenue and entity/collection-level metrics, were calculated using Flipside's data tables. The specific data source referenced in these calculations is Flipside's ethereum.core.eznftsales SQL database table, from which records with a creatorfeeusd parameter greater than 0 were extracted. The royalties for collection-level NFTs in Flipside were then manually inputted to generate the final graphic of the top ten "royalty harvesters."

How Royalties Work

NFT royalties have always been a less transparent dimension of NFT transactions. First, royalties are paid by the seller rather than the buyer, similar to the commission system in real estate transactions. Second, royalties are not supported by code at the token or contract level. Specifically, the transfer mechanisms of smart contracts (such as Ethereum's transferFrom() function) cannot be used to calculate the royalties due because these functions are also used when collectors transfer NFTs between their own wallets.

The only way to encode NFT royalties into smart contracts is for the program to add input parameters to determine the owner's behavior—whether they are executing a transfer between their own wallets or interacting with a buyer's wallet. This means that without introducing management measures such as intermediaries for centralized management, tracking wallet and asset ownership, or revoking user-custodied assets based on user behavior, which undermines the self-sovereignty of digital assets, this programmatic behavior recognition cannot ensure authenticity. Furthermore, even if a program is added to the contract, forcing users to pay extra fees to "clear their name" can lead to a poor experience, and NFTs may still be wrapped in contracts to avoid paying additional NFT royalties during transactions.

In the latest episode of "The Chopping Block," Haseeb Qureshi from Dragonfly and Zhuoxun Yin from Magic Eden discussed the trilemma between a successful and complete royalty payment system, decentralization, and Turing completeness. Successfully optimizing these three attributes is currently unfeasible, which is a key reason why NFT royalties have not yet been implemented at the token or smart contract level.

Due to the technical challenges at the smart contract level, royalties have become a guideline enforced by the NFT market. In other words, royalties are enforced by social norms, and the market effectively collects royalties on behalf of creators as an incentive for their ongoing creation (similar to tips).

As a result, most NFT markets have implemented royalty payment solutions to attract creators with a continuous revenue stream. This was particularly important in the early stages of NFT market development, as protocols needed to appease both sides of the market—creators and collectors. Now, as the NFT space has matured significantly over the past two years, the market has made corresponding adjustments. As mentioned, some markets like SudoSwap have completely eliminated royalty payments to attract as much liquidity as possible.

OpenSea currently accounts for over 80% of NFT market trading volume, and its royalty distribution method is the most common framework in the market today. In this framework, creator royalties are defined at the NFT level and must be set by the collection owner in the collection-level settings on OpenSea. In this process, creators also need to link a wallet address to the collection, which will be used to receive accrued royalties from OpenSea periodically (usually every few weeks). Royalties generally range from 2.5% to 10% of the final sale price. Sellers always pay both royalties and the transaction fees charged by OpenSea in each transaction. These are usually just estimated prices; in actual transactions, buyers only need to pay the price of the NFT reported by OpenSea (or the winning auction price) and gas fees.

Summary

NFTs have fundamentally changed the economic relationship between creators and consumers, giving rise to the concept of secondary sale royalties for creators. Before this concept emerged, artists only profited from the primary sales of their works. This economic model meant that revolutionary avant-garde artists could not earn more income as their works gained recognition. For example, the famous artist Vincent van Gogh struggled with poverty throughout his life and sold "The Red Vineyard" for just 400 francs in Belgium a few months before his death.

While he was virtually unknown during his lifetime, from a contemporary perspective, van Gogh is undoubtedly one of the most famous painters in history, having generated over $670 million in secondary sales after his death. It is easy to imagine that if van Gogh could have received royalties from secondary sales, this continuous revenue stream could have been used to fulfill his wishes (such as art education programs).

On one hand, NFT royalties provide creators with a way to earn additional income through the ongoing success of their works. This business model is particularly beneficial for digital artists and musicians, who have traditionally struggled to recoup profits from traditional distribution channels like galleries and record labels. On the other hand, some in the crypto community increasingly believe that buyers should hold complete ownership of NFTs, and that paying royalties to creators is fundamentally unfair. Crucially, NFT royalties are currently enforced by the market itself, rather than being hard-coded into the issued smart contracts. The decentralized nature of the crypto space has given rise to various NFT market structures that position royalty-free NFT trading as a core value proposition.

Recently, ongoing skepticism regarding the enforcement of NFT royalties at the market level has prompted a wave of transformation among the leaders in the NFT ecosystem. The DeGods ecosystem recently removed royalties from all its affiliated NFT collections (such as DeGods and y00ts). Although DeGods founder Frank has repeatedly defended the rationale for royalties on Twitter and still believes that royalties are the best incentive alignment mechanism between NFT collection operators and holders, this move still occurred.

While OpenSea is currently taking a wait-and-see approach, smaller exchanges like x2y2 have already taken action to change royalty payments (or eliminate royalties). Additionally, the Solana NFT market giant Magic Eden made a controversial shift, making all royalties on its platform completely optional. Considering that Magic Eden announced MetaShield in September 2022, a controversial tool aimed at improving royalty enforcement, its recent move to eliminate royalties is particularly noteworthy.

In this debate, both sides present compelling arguments. While royalties have proven to be a reliable source of income for collectors, they are unenforceable at the smart contract level, as evidenced by the rise of markets without royalties. The NFT community seems to be divided on the ideology supporting royalties, with some believing that royalties are beneficial for the healthy development of the NFT ecosystem, while others argue that royalties are exploitative and unnecessary.

Given the significant stakes in potential revenue streams, this issue could have long-lasting impacts on the NFT space in the coming years. In this report, we will explore the issue of NFT royalties from multiple perspectives and propose how we believe this critical issue will evolve.

A Brief History of NFT Royalties

Compared to the NFT space itself, NFT royalties are a relatively new phenomenon. CryptoPunks, considered the godfather of 10,000 generated PFPs, never charged royalties when they debuted in 2017. The official CryptoPunks marketplace is the only market for Punks trading and still does not charge any royalties on secondary sales. The creators of CryptoPunks, Larva Labs, chose a different business model, opting to hold 1,000 Punks and generate revenue through occasional sales.

Subsequently, Yuga Labs burst into the NFT space in mid-2021 with its Bored Ape Yacht Club series, showcasing the economic appeal of a royalty-driven business model in the process. Although BAYC only generated $2.2 million in primary sales when it launched in May 2021, the series earned Yuga Labs $54 million in secondary sales by charging a 2.5% royalty on each BAYC transaction.

To date, Yuga Labs has earned an astonishing approximately $140 million in royalties from all its series. Other NFT projects have taken note of Yuga's successful royalty model and established a 2.5% royalty as the industry default standard. As the NFT market continued to heat up in the second half of 2021, supported by series like Azuki, Doodles, CloneX, and Moonbirds, the 2.5% industry standard quickly rose to 5%. Yuga Labs also raised its royalties, launching the Otherdeeds series with a 5% royalty and changing Meebits from 0% to 5% royalties. Since its launch in April 2022, Otherdeeds alone has generated $44 million in secondary sales for the company.

Since the frenzy of Otherside sales, royalties have been on the rise. For example, Goblintown released a completely free collection inspired by a viral meme campaign on Twitter. Behind the veil of "anti-Discord, anti-Roadmap, anti-utility," Goblintown quietly charged up to 7.5% in royalties on all secondary sales, ultimately bringing in about $7 million in revenue, while this lucrative collection series was merely a memoir.

The highest royalties likely belong to NFT Worlds in the metaverse series, which, despite NFT Worlds land sales dropping 94% from historical highs and the platform having only 235 daily active users, still earned the team $15 million in net income from royalties as high as 9.5%. Given the poor performance of the collection and sluggish user growth, some community members have expressed dissatisfaction with the project's founders continuing to collect royalties.

The sweeping bear market has had a significant impact on both NFT prices and quantities, leading to increased price sensitivity among users. The market has also begun to oppose earning continuous revenue through royalties. Although this ambitious vision has not yet been realized, the ongoing discontent brewing in the broader market environment, combined with recent innovations in market structure, ultimately ignited the climax of the NFT market's "anti-royalty movement."

The Storm Ahead

Launched in July 2022, SudoSwap is a pioneer of the anti-royalty movement in the NFT space, utilizing AMM for NFT trading (similar to how Uniswap works for fungible tokens). The AMM model they use aims to improve NFT liquidity and market making while minimizing fees. SudoSwap not only charges a relatively low 0.5% transaction fee (compared to OpenSea's 2.5%), but they also do not support any collections that charge NFT royalties.

While SudoSwap's trading model is most effective for floot NFTs, their core value proposition has been embraced by sellers looking to maximize their profit margins—sellers do not need to incur losses of up to 12.5% on royalties and platform fees, but instead ensure that they pay a maximum of only 0.5% per transaction.

After SudoSwap became the preferred destination for NFT trading, Gem also saw an opportunity. Acquired by OpenSea in April last year, Gem is an NFT marketplace aggregator that helps users sweep floor NFTs at the lowest prices. Gem began incorporating SudoSwap into its aggregator list, a small move that led the entire NFT field to interpret Gem's integration with SudoSwap as a form of endorsement from OpenSea.

Soon after, another NFT marketplace, x2y2, began to follow suit, allowing buyers and sellers to choose whether to pay royalties. While x2y2 eliminated royalties for NFTs on the Ethereum chain, Yawww announced a similar move on Solana, making royalties optional. Subsequently, HadeSwap, which debuted in mid-summer, directly copied SudoSwap's royalty-free AMM model for Solana NFTs. By September, the royalty-free movement that began with Ethereum NFTs had sparked another wave on Solana NFTs.

Magic Eden, which has historically held about 90% of the Solana NFT market share, faced challenges to its dominance with the rise of royalty-free alternatives like Yawww and Hadeswap. Data from Tiexo shows that Magic Eden's market share began to plummet in October, dropping from around 90% to as low as about 60% in just a few weeks. In response to this "market position," Magic Eden quickly announced that it would also introduce royalty options on its platform to compete fairly with these rapidly rising challengers. Since the announcement, Magic Eden's market share has rebounded to around 90%.

Interestingly, compared to the Ethereum NFT ecosystem, the Solana NFT ecosystem appears to be more sensitive to this ongoing royalty dispute, as evidenced by the significant loss of Magic Eden's market share before the elimination of royalties, whereas OpenSea's market share loss has been much smaller. One possible explanation is that Solana NFT traders are more likely to be hired hands, often realizing that profits come from turnover and speculation rather than from long-term holders and retail users.

In contrast, on Ethereum, buyer motivations are more about "holding more high-dollar-value collectibles," such as Fidenzas and Punks, who may be more interested in displaying status and storing value among these rare collectibles rather than frantically speculating on them for quick profits. In other words, a small royalty percentage is unlikely to shake the determination of these high-net-worth users to continue pursuing "high social status."

Tyler Hobbs, the creator of Fidenza and QL generative art collectibles, believes that the behavior of the Ethereum NFT community is fundamentally different from that of the Solana NFT community. Hobbs states, "Strict artists and collectors tend to create on Ethereum rather than Solana. This is a better test for these systems, and creators will face more intense struggles on Ethereum." So far, Hobbs' view that the Ethereum NFT community will fight to maintain royalty rights seems to be correct, as OpenSea, which enforces royalties, remains the mainstream platform.

Beyond individual creators, major brands like Nike, Gucci, and Adidas would also lose tens of millions of dollars in potential revenue if royalties are no longer enforced. These large traditional institutions and well-known creators will also strive to retain royalty-driven revenue streams from NFTs on the Ethereum chain.

The Royalty War

In the ongoing "royalty war," two main schools of thought have emerged. Proponents argue that since projects often start with lower primary sales but gain popularity in the months following their release, creators have the potential to earn more money over time as their projects become more popular.

DeGods and BAYC are two obvious examples of NFT collectibles that had low primary sales at launch but entered the upper echelons of their respective ecosystems in less than a year. Supporters of royalties worry that eliminating royalties would return the NFT space to the dark ages of traditional creator incentive structures, as experienced by van Gogh.

On the other hand, opponents claim that without an enforcement mechanism, royalties cannot be implemented on-chain, and the so-called "enforcement" is a ruthless denial of many advantages of blockchain. Even Solana's creator, Anatoly Yakovenko, admits that the only feasible way to enforce royalties at the token level is to reconstruct the concept of ownership. In his view, NFT ownership can be split between the user and the creator-defined smart contract. This would allow the creator's smart contract to implement royalties and grant them the power to revoke a user's NFT if they fail to comply with the royalty parameters specified in the token's smart contract.

This structure poses obvious risks to the concept of self-sovereignty, and many believe it contradicts the entire purpose of NFTs. Royalty opponents also argue that collectors in the NFT space are very price-sensitive and will increasingly favor markets that offer the lowest fees. In their view, fighting for royalties is unrealistic, and inevitably moving away from royalties means creators will better develop more sustainable business models.

Several major NFT participants have already proposed solutions to address or strengthen royalty enforcement.

Implemented Measures:

Tyler Hobbs' QQL mint card is the first major NFT project to avoid trading with 0% royalties at the smart contract level. This feature is achieved through a blacklist filtering contract that checks whether msg.sender (the person attempting to purchase the NFT) is on a blocked username list during transaction validation.

If the msg.sender is detected as a blacklist user, the transaction will automatically fail. This means Hobbs has blacklisted royalties currently in the market. The QQL project highlights that if NFT markets have the privilege to decide whether to follow the royalty system, then NFT creators should also have the privilege to decide which markets can sell their artworks.

Although Magic Eden later changed its mind, they initially attempted to combat the 0% royalty movement with a tool called MetaShield. This optional feature allowed creators to track and identify Solana-native NFTs listed on 0% royalty platforms, such as Yawww.

Through MetaShield, creators of these projects could intentionally modify the metadata of NFTs attempting to circumvent royalty payments. The MetaShield tool could not only obscure or erase NFT images but also establish a penalty system for buyers—if a buyer purchases an NFT that bypasses royalties and is blocked, they would accumulate a debt for unpaid royalties. This debt must be paid to "unlock" the protection of the NFT image. Although Magic Eden faced criticism for this buyer liability system, the company clarified that it was a mechanism set up to express recognition of creator rights.

Manifold is one of the most noteworthy NFT smart contract developers and tool providers, proposing an eye-opening solution to the royalty distribution crisis. Manifold has partnered with OpenSea, Rarible, Nifty Gateway, and SuperRare to launch an on-chain contract that makes it easy for markets to comply with the required royalties of projects. The key issue Manifold is addressing is that creators must manually update their desired royalty percentages in every market where their NFTs are traded. The problem with this mechanism is that emerging exchanges cannot effectively perceive NFT royalty preferences.

Moreover, if a creator's royalty preferences change, they need to manually update their preferred royalties in each exchange. Manifold is creating tools that allow creators to update their preferences on-chain, standardizing this cumbersome process. Manifold refers to this as a royalty registration contract, enabling previously unsupported on-chain royalties in smart contracts to easily add similar functionalities. While the "royalty registry" may not necessarily help enforce royalties, it does make it easier for developers to comply with creators' existing royalty preferences on-chain. This approach is very similar to the initial proposal in "EIP-2981: The NFT Royalty Standard."

Outlook, Conclusion, and Potential Solutions

While NFTs continue to evolve, the future of royalties remains uncertain. Although data indicates that Ethereum NFTs still have a strong user base willing to pay royalties, royalty-free markets have shown such remarkable growth in a short time that one thing is certain: as industry stakeholders weigh the pros and cons of this contentious issue, the future revenue streams for NFT creators remain undefined. Only time will tell whether creators will continue to benefit from secondary sales or whether they will lose potential income due to a "pure" ownership model.

As this vibrant market continues to grow and mature, it will be interesting to observe how stakeholders carefully consider this ongoing "war" and potential long-term solutions. Some potential solutions include the following:

Buyer Premium: In Beeple's view, shifting the responsibility for royalty payments from sellers to buyers makes a lot of sense. Since buyers are seeking opportunities to enter the NFT ecosystem or utilize additional functionalities that can be realized based on NFTs (such as accessing Discord, staking for rewards, or playing games, etc.), buyers may be more willing to pay royalties. Meanwhile, in all the aforementioned use cases, royalty payments can be checked programmatically before granting users access.

From the seller's perspective, since they are selling a collectible, they are less willing to pay additional fees at the exit point. It is understandable that sellers are "profit-driven" when pricing NFTs. This situation is exacerbated by the increasing speculation among NFT traders, as their actions of going long or short on NFT positions stem solely from the pursuit of profit.

Market Platform Vertical Integration: When Crypto Punks first debuted in 2017, they could only be bought or sold on Larva Labs' marketplace. By controlling the market, Larva Labs was able to enforce its own royalty policy (0%). Today, Yuga Labs and RTFKT are building their own marketplaces. This trend of vertical integration bears many similarities to the rise of direct-to-consumer models in the e-commerce landscape over the past decade.

For example, Amazon parallels OpenSea, maximizing distribution while minimizing profit margins, whereas companies with their own storefronts on Shopify can retain more profit margins. While vertically integrated market platforms are unlikely to capture a significant share of the NFT trading market, this trend may ensure that some degree of royalty collection always exists.

Other Revenue Streams: In the absence of guaranteed royalties, some collectibles may face revenue pressure, making "subscriptions" a reliable business model for maintaining creator income. Collectibles under revenue pressure can monetize their IP through merchandise sales or non-cryptocurrency avenues such as live events, restaurants, TV shows, games, and movies.

While in the long run, "subscriptions" may force the ecosystem to "think long-term," potentially having a positive impact on NFTs, failed attempts are also inevitable. When revenue streams outside of the core business exist, the key question becomes, "What is the purpose of NFTs?" If NFT revenue streams resemble those of the physical economy, then this approach is logically sound. However, those who believe that NFT collectibles belong to a decentralized community and should not be profit-driven may feel disappointed by this trend.

Increasing Mint Prices: The simplest way to reduce royalties is to increase sales revenue. This approach may only be effective in mature NFT ecosystems with successful track records. However, we have indeed seen that over time, as we have observed in the past year, mint prices may also trend upward like royalties. However, due to irrational incentive mechanisms, this trend of increasing mint prices may also lead to an increase in scams—new projects raising more funds in the early stages may result in teams being less willing to provide long-term value.

Cumulative Royalty Rebate System: Initially proposed by jota.sol, this method is somewhat similar to the cumulative rebate system in historical books. As the value of goods increases, the tax rate decreases. In the NFT system, the higher the value of a specific NFT, the lower the royalty percentage generally charged upon sale. The implicit economic principle behind this method is the Laffer Curve, which assumes that extreme values of taxation yield suboptimal results in revenue generation. In other words, there may be a royalty fee rate greater than 0% that most traders are willing to pay on the Laffer Curve.

Strengthening Off-Chain Utility: This is similar to the initiatives of Tyler Hobbs and MetaShield, but it focuses entirely on off-chain use cases. The core idea is that many users purchase NFTs to access off-chain resources (such as games, staking platforms, Discord servers, etc.), and this method would simply gate access to those resources based on whether NFT owners have paid royalties.

This has already been seen in NFT Discord servers, where participant identities are maintained by royalty payments, and enforcement mechanisms typically check whether NFTs were purchased on royalty-free exchanges (like x2y2). For example, x2y2 may "publicly execute" those who purchase NFTs using royalty-free exchanges, prompting buyers to migrate back to exchanges that enforce royalties to retain the added value of their NFT applications.