On Royalties

A wonderful tool that doesn't quite fit, and what comes next

Royalties have provided wonderful income for artists and creators. If you're making money off them, that's great! But they’re unenforceable and thus a poor fit for blockchains. Here I’ll explain why royalty reliance is unsustainable and how artists can consider more reliable monetization mechanisms.

My goal is not to tear down, but to help understand what's sustainable and what's not. Seek to build proactively in alignment with your medium, not fighting it tooth and nail. Creators who fully lean into the cryptonative mindset of creating decentralized bearer assets with thoughtful mechanism design will be richly rewarded.

• Royalties misalign incentives

• Royalties are not enforceable

• Centralization destroys the value prop

• How creators can sustainably monetize

Royalties Misalign Incentives

Take a long hard look at the chart below. 6.9% creator royalties, several hundred ETH extracted, millions of dollars gone to a free pump-and-dump mint. Bloot was a failed project that left collectors with nothing, while the creator team still realized upside from royalty profits.

Bloot, an infamous free mint pumped by Beanie & co. Despite doing 9,000 ETH of volume, the floor now sits below 0.01 ETH, the vestiges of desperate tax loss harvesters.

Creators should be rewarded based on collection marketcap, not collection volume. There’s a clear incentive distortion that pays creators based on how much volatility and holder turnover they have, while they earn nothing from diamond-handed true believers. This explicitly encourages low-quality pump-and-dump free mints, so it’s no coincidence that’s what we got.

Traditional financial fiduciaries get paid based proportionally to profits, not proportionally to trading volume. When a collection is dumping to zero because the community learned unsavory details about the founding team, it’s not right for that same unsavory founding team rake in additional secondary fees.

What’s a better incentive alignment model? Creators should make money when collectors make money - it’s that simple. A couple options: (1) Creator holds a portion of supply; (2) Creator earns a share of sale profit rather than sale price; (3) Creator earns a rolling percentage of current project valuation through harberger taxes.

Royalties are not Enforceable

NFTs are decentralized bearer assets. Bearer asset means that the person holding it has ownership and full control, decentralized means that ownership/control cannot be revoked by a third party at a later date. It is impossible to enforce royalties onchain without introducing centralized control or breaking wallet-to-wallet transfers.

The first concept to understand is side payments. A side payment is when Alice pretends to sell to Bob for a low price onchain, and then sends additional money separately. The true price cannot be checked in the sale transaction itself.

The second concept to understand is wrapper contracts. A wrapper NFT collection points at an original NFT collection, and lets users mint wrapped versions of their NFTs by sending the original NFT into escrow. The wrapped NFT then acts as a claim on the underlying, and can be traded freely without any restrictions the original NFT creator might have coded into the contract. See Wrapped Penguins, an experiment in the community revolting against Cole before he sold the project ownership.

Wrapped Penguins, a community rebellion led by Vincent Van Dough against Cole’s perceived ineffective leadership.

The third concept to understand is free wallet-to-wallet transfers. Rotating wallets is a basic aspect of recovering from hacks, financial hygiene, key management, privacy, and personal security. While a select few experiments such as veTokens limit transfers, even this has fallen out of favor to the transferrable veNFT. Some people have proposed breaking this functionality by letting a centralized admin revoke transfers post facto, adding KYC requirements to prove ownership of both wallets, or adding a fixed fee on transfer. However this cure is worse than the disease, and strikes at the heart of crypto ethos.

Now, debunking a couple common ideas:

• What if you hardcode a royalty into the token? This generally just illustrates a lack of understanding of how ERC721s operate. Trades take place at the marketplace contract level, using approvals and transfers.

• What if you hardcoded a fixed fee for any token transfer? This is not a royalty, just a transfer tax. It breaks transfers from one personal wallet to another. It can be removed with a one-time transfer to a wrapper contract.

• What if you hardcoded a price oracle fee for any token transfer? Running a price oracle is both difficult and centralized. This breaks transfers from one personal wallet to another, and can be removed with a one-time transfer to a wrapper contract.

• What if you blacklisted marketplaces that don’t respect your royalty?
  You can’t blacklist websites, you can only blacklist contract addresses. Marketplaces move contracts, and new ones launch all the time. Cloned code appears at a different address. It’s a constant cat-and-mouse game. This requires permanent administrative control, and the risk of accidentally or malicious bricking tokens.

• What if you let the artist revoke token transfers that didn’t pay the royalty? See the next section.

Centralization Destroys the Value Prop

Given arbitrary programmability, the only “solution” is to grant the creator permanent admin access to blacklist addresses, burn tokens, or revoke transfers. For cryptonative collectors, this is an unacceptable tradeoff with clear tail risks. DCinvestor said it best:

DCinvestor.eth ⌐◨-◨ @iamDCinvestor

i will also never buy a NFT which includes code which might limit my ability to transfer that’s not because i won’t pay royalties, but because i believe NFT are best as permissionless, censorship-resistant bearer assets break that, and they become much less interesting to me

August 27th 2022

13 Retweets157 Likes

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

How Creators can Sustainably Monetize

The reason to move away from reliance on forced royalties is not because they’re morally wrong. As described above, in the long run they just don’t fit into the permissionless blockchain paradigm. You use different tools for painting a canvas than for sculpting marble. So what tools work best on blockchains?

1) Creator Owned Liquidity

The creator can hold back a portion of the supply for themselves. This worked for LarvaLabs, this worked for 8liens, and numerous others. With NFT financialization tools like sudoswap, you can earn trading fees without dumping on followers.

2) Social Leaderboards for Voluntary Royalties

Even if royalties are unenforceable, many wonderful actors in the space want to pay royalties. So making a public leaderboard with info about who has voluntarily supported artists could gamify and encourage prosocial behavior.

3) Primary Sales after Proving Yourself

Also quite lucrative - see LarvaLabs, YugaLabs, XCOPY, deekaymotion, etc.

4) Companion Works after Proving Yourself

Some say this is bad because it requires the artist to have a following. Unfortunately this is a result of the attention economy, and building your own brand is a requirement in any monetization case. An unknown creator who can't sell a primary drop won't be making any money on royalties.

5) Official Endorsements of Derivative Works

Provenance is everything in crypto. So how can the original creator of an idea accrue value from spinoff derivatives? Your very word holds powerful weight, even an endorsement of high-quality derivative work can prove quite lucrative.

6) Harberger Taxes

Harberger taxes are the cryptonative equivalent of royalties. Each NFT owner makes a personal evaluation of their token’s worth and pays a small percentage of that to the creator on a regular basis. Anyone can buyout the token at current owner valuation at any time, preventing lowball valuations. If you smooth the payments rather than discretize them, this is compatible with free transfers, solves the price oracle problem, and is decentralized. There are some tricky UX concerns here around what it means to own a token, but something worth exploring.

A Philosophical Footnote

I don’t consider myself a strong visual artist, but do love collecting art. I’m most heavily a creator in the mechanism design space.

Here’s a secret: simplicity wins. This might sound like a lazy copout, but the reverse is true. It’s intellectually harder to build a simple protocol that works than to build a complex one with many patched edge cases. The latter feels satisfying, because you’re working hard and chugging through tasks. But it’s often not what works best, or even what users want.

Complexity or excessive edge cases are often a symbol that you’re trying to fit a round peg into a square hole. It’s mechanism feedback that something isn’t right here. Build things that flow naturally through their underlying environment without requiring excessive control. Resist the urge to blacklist, to socially shame, to write too many if-then statements. Both you and your users will be happier.

This applies to royalties, and a lot more.