NFT Royalties Explained: How Does Royalties Work?

NFT Royalties have become a big topic in the NFT space.

Especially, after many NFT marketplaces have gone with the optional royalties, which reduced the revenue for NFT projects.

Ok, what actually is a royalty here? How does it work? and Who is getting paid because of these royalties?

Let’s get right into it.

What are NFT Royalties?

NFT royalties are essentially fees paid to the original creator of an NFT each time it is resold.

These royalties serve as a way for artists to continue earning money after the initial sale of their NFT.

It’s like a never-ending stream of income from a single digital asset.

For popular NFT collections, this can result in substantial earnings, sometimes reaching millions.

In general, the royalty set is 2.5% to 10% of an item’s purchase price. Most royalties average about 5%.

Although the majority of the earnings a creator earns is by selling their work, secondary sales can build out their income through royalties.

How Does NFT Royalties Work?

Let’s understand how royalties work with an example!

Imagine an artist named Sarah. Sarah created a digital artwork and decided to mint it as an NFT on a blockchain platform. During the minting process, Sarah sets a royalty percentage of 5% for her artwork.

Initial Sale:

Sarah lists her NFT for sale, and a collector named Alex purchases it for 2 ETH (Ethereum).
Sarah receives 2 ETH from the initial sale of her artwork.

Resale:

Over time, Alex decides to sell the NFT to another collector, Taylor, for 4 ETH.
Since Sarah had set a royalty percentage of 5%, a portion of the resale value goes to her as a royalty fee.

The smart contract automatically calculates Sarah’s royalty: 5% of 4 ETH is 0.2 ETH.
Sarah receives 0.2 ETH as a royalty payment, while Alex receives the remaining 3.8 ETH from the resale.

Subsequent Resales:

The NFT continues to change hands in the secondary market, with each resale triggering a royalty payment to Sarah based on the percentage she specified.

For each subsequent resale, Sarah receives a percentage of the resale value, providing her with ongoing income from her artwork’s success.

Note that the way Royalties work with NFT Marketplaces is Creators have to manually register royalty percentages with each marketplace in the ecosystem.

Then the marketplace would take that royalty from every NFT sale and transfer it to the creator.

And that gets us one of the biggest problems faced by NFT Creators.

NFT Royalties Can’t Be Enforced On-chain

A lot of artists and creators got into web3 with the hope of a fair distribution of their work by embracing these blockchain-based NFTs.

But that hope is lost as many NFT marketplaces started to make creator royalties optional on their platforms in an attempt to attract more buyers. This has been a good move for traders and buyers, but didn’t benefit the creators, of course.

It came down to this: Royalties only work if the marketplace where the work is sold respects it and deducts and transfers the fee at the time payment is made.

BTW, this is X2Y2 again, after the backlash:

And yes, there is no solution to enforce royalties, directly on-chain.

When an artist first sells their work as an NFT, they typically receive proceeds from the initial sale.

However, if the buyer later resells the NFT on secondary markets like Rarible for a higher price, the artist doesn’t receive any royalties from these subsequent sales.

The problem stems from the current design of NFT marketplaces, where smart contracts are unable to communicate with each other effectively.

This means that royalty payments are tied to the marketplace where the NFT was originally minted, and subsequent sales on other platforms don’t trigger royalty payments for the artist.

The creator’s royalty is typically tied to the marketplace where the NFT was first minted.

Consequently, if a buyer decides to list the NFT on a different marketplace, the original creator may miss out on royalties generated from subsequent sales.

The ERC-721 token standard, followed by most NFTs, includes a crucial function called “transfer from,” facilitating NFT movement between addresses, essential for trading on various marketplaces like OpenSea (has royalties) or SudoAMM (has no royalties).

Image Source: A16z Crypto

Conclusion

Royalties offer artists and creators an ongoing income streams from secondary sales of their digital assets.

However, the inability to enforce royalties directly on-chain poses a challenge, as many marketplaces have made them optional, potentially depriving creators of rightful earnings.

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