The Breakdown - Are NFTs Still Disruptive in a Zero-Royalty World?

Starting point is 00:00:00 Automated royalties are one of the most disruptive aspects of NFTs for artists and creators. The market has shown that people have made a lot more from royalties than from initial mints. But market pressures and competition are pushing NFT marketplaces to not enforce royalties. This is reminding people that royalties are not enforced on a protocol level and are really more about social consensus and market norms. There's a lot of bluster and anger right now, but ultimately a lot of this is going to be a social market question of where norms should land. Welcome back to The Breakdown with me, NLW.

Starting point is 00:00:30 It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Circle, and FTX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, October 17th, and today we're talking about NFT royalties and what they mean for the disruptive potential of NFTs. Before we dive into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conference. conversation. Come join us on the Breakers Discord. You can find a link in the show notes or go to bit. LY slash breakdown pod. Also a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. All right, folks, happy work week. We are back again. Thanks for all of your nice messages about being sick. As you can tell, I'm still a little under the weather, but not quite as

Starting point is 00:01:23 parched as I was by the end of last week. Anyway, today, we are looking at an interesting discussion happening in the NFT space. And as I've mentioned before on this show, NFTs aren't exciting to me necessarily for the same reasons that they are for many people. I'm not in the business of yucking anyone's yum, but the part that is interesting to me follows the same sort of big picture power shift questions that the show does. I've always been interested in the idea of artist, creators, musicians in particular, having a better ability to work around systems that are historically exploitative because of their centralization gatekeeping and control. One aspect of that when it comes to NFTs was the ability to make money in a continuous ongoing way through programmatic royalties that wouldn't leave them reliant on centralized platforms to actually get that payment.

Starting point is 00:02:12 The discussions that are happening in the industry right now have a pretty dramatic impact on whether that's a promise that could actually come true. Indeed, right now, it seems like things are heading in a slightly different direction, and that was the main discussion basically all weekend on NFT Twitter. So here's where it started. On Friday night, Salana NFT Marketplace, Magic Eden, announced they would be moving to optional royalties payments on their platform. They tweeted, After some difficult reflection and discussions with many creators, we've decided to move to optional royalties on Magic Eden.

Starting point is 00:02:43 Effective later today, we will also begin running a promotion to waive our platform fees. This is not a decision we take lightly. We understand this move has serious implications for the ecosystem. We also hope it is not a permanent decision. Today, royalties are not enforceable on chain. We welcome and hope to see new standards that protect royalties. The market has been shifting towards optional creator royalties for a while. Editors note the chart that they show on this tweet shows how optional royalty marketplaces

Starting point is 00:03:10 have gone from zero to something significant, more than tripling in the last month. Back to their thread. We've been actively trying to avoid this outcome and spent the last few weeks exploring different alternatives. Unfortunately, royalties are not enforceable on a protocol level, so we have had to adapt to shifting market dynamics. How will optional royalties work? We've consulted with traders and creators and have come up with the following experience.

Starting point is 00:03:34 The decision on how much royalties to pay will be passed to the buyer. By default, all collections and listings will honor full royalties. Our rationale for shifting royalties payments to the buyer is to make sure the buyer has a full understanding of whether they are going to receive the benefits that the creators provide, discord, staking, etc. We are going to review our marketplace fee structure as well. For the foreseeable future, Magic Eden will not be making. any percentage of sales. Again, we hope this decision is not permanent. If you are working

Starting point is 00:03:59 on pro-royalty tools or alternative business models, we want to hear from you. So, what's going on? Well, right now, it feels like this is sort of a consequence of, one, the bare market, two, competition, and three, perhaps unexpected or unrealistic technological limitations. So let's move back a little bit and talk about what royalties were. As I mentioned at the intro, one of the exciting things about NFTs was the potential to disrupt and automate the way that digital intellectual property is handled. Embedded royalties were a way to disintermediate the middlemen out of the royalties providing a way for artists to keep more of their royalties for use and resale of their work. This worked reasonably well during the NFT boom in 2021, notably while they were still a near monopoly on

Starting point is 00:04:40 NFT marketplaces. However, now that NFTs are deep in bare market territory, it appears that marketplaces are desperately competing for volume, and royalty payments to artists represent an additional cost to sellers that marketplaces can toggle to try to win in that intense competitive environment. In August of this year, X2Y2 also removed compulsory royalty enforcement. Similar to the Magic Eden decision, the removal of royalties enforcement was in reaction to the growth of NFT-automated marketmaker's pseudo-swap, which had no royalty payment. This new competition for marketplaces and market structure allowed traders to trade in an aggregated pool of floor NFTs rather than individual items and entirely avoided those royalty payments. Speaking in a Twitter space is held shortly after

Starting point is 00:05:21 the announcement, a Magic Eden representative said, it's very sad. It's very sad. It's very very tragic. We did not want to be in this position, but the market has already spoken in regards to optional market royalties. It was effectively a race at the bottom. Now, one of the things that this whole episode points out is that royalty payments are not enforced by NFT token standards. When minting an NFT, there's an ability to code in a royalty, but this merely acts as a suggestion, with marketplaces being required to enforce the payment. Obviously, not having the ability to enforce royalties or not being willing to enforce royalties, pretty significantly undermines the usefulness of NFTs in applications such as the automation of music royalties, or establishing

Starting point is 00:05:57 a culture of paying royalties on the resale of art. Part of the issue is made clear by Magic Eden's announcement is that royalty payments which were seen as reasonable and happily paid during a raging bull market can quickly seem extortionately high when a seller is already selling at a loss during a falling market market and in the context of reduced volumes on marketplaces. And of course, there's a question of incentives. If marketplaces are desperately competing to keep what is currently a dwindling user base? Are they going to enforce optional royalties or look for any edge they can get? Now, this conversation is really one that's happening in the NFT space, of which I am more an observer or tourist than actual participant. So for most of the rest of the

Starting point is 00:06:34 show, I want to turn to threads from people who are in that space to see how the community is discussing this. By way of background, Punk 9059, the director of research at proof.xyZ, wrote a 20-page research report on NFT royalties. Luckily, alchemical crypto did a summary thread that we have here. 1.5 billion have been paid from collectors to creators and royalties. Between July 21 and 22, the median open-sea royalties increased from 4% to 7.5%. ETH created from royalties is much more than ETH created from mince. Now, zero royalty exchanges, such as pseudoswap, have seen an increase in market cap, especially in newer projects, but also in some of the older large-cap ones like Doodles. At the same time, OpenC has seen a 10% decrease in market share, from 85% to 75%.

Starting point is 00:07:21 There's been a trend to see projects increasing their royalties. In early 21, for example, OpenC had 2.5% royalties, which increased to 5% by later that year. When Free Mint started emerging, so did higher royalties. Goblin Town, for example, was 7.5% with NFT World at 9.5%. In the first 15 days of June, Goblin Town had more royalty revenue than BoredApe Yacht Club, other deed, clone X, Moonbirds, and Azuki official combined. Most marketplaces have hidden the royalties from their website. OpenC has now made them more visible. Hoping for a two to three X flip, collectors don't care much about the royalty. Biers are happy to support a different system on how creators and their

Starting point is 00:07:58 teams are getting paid. So pros of royalties, artists are being compensated for their creative work, low mint prices and royalties drove many projects to success, EG, BAYC, Fidenza, World of Women, long-term holders can benefit since creators can earn from short-term traders. The cons, include incentive misalignment, higher royalties can hurt liquidity, increase in hacks, aka buyers trading off market to avoid royalties, and more. Now, really importantly, it's almost impossible to enforce on-chain royalties, which means creators have left it to the hands of the exchanges. From there, the thread, which is again just a summary of this report, looks at all of the different ways the market might be evolving. So digging in a little further to community takes,

Starting point is 00:08:36 The main thrust of them is that this is actually kind of a big deal and that it's kind of a huge problem. Silly Tuna said, Royalties have been one of the biggest sales pitches for NFTs, particularly to brands and established artists. Essentially removing them is a spectacular way of shooting ourselves in the foot and plays fully into the idea that NFTs are only about trading. Stop this idiocy. Gino the Ghost, the co-founder at Blocktones, writes, Imagine me trying to onboard musicians into Web 3 with 0% royalties.

Starting point is 00:09:02 Hey, are you tired of making 0.003 cents a stream in royalty? At Spotify? Head over to Web 3 where you can make 0.0000 cents in royalties. Stock Lurzard King says no royalties equals higher mint prices, subscription fees, projects minting their own supply and selling on secondary, more VC projects that are out of touch with what the space wants, more rugs, less innovation. Salana Legend writes, to people who are pushing extremely hard for 0% royalties, most of you are terrible traders and will still lose money even with 0% royalties and fees. You don't understand the second order effects of what you've just done. These traders couldn't make money in Web 2 or Web 3. They won't make money in

Starting point is 00:09:38 Web 4 either. It's a mentality issue. David Bianchi writes, anyone in the NFT space that is pushing zero royalties is destroying the fabric that makes the NFTs in Web 3, the Renaissance it is. You're also destroying the artist's abilities to sustain and change the global economy for those underserved. Shame on anyone pushing for 0%. A number of project founders also felt like this was basically big projects pulling the ladder up behind them. Betty, one of the founders at Deadfellas, writes, none of the big NFT projects would have made it big without royalties. Your short-term mindset to save 2.5% on a transaction will prevent most smaller projects from ever leveling up unless they sell their soul to a VC, which also isn't easy unless you're connected. There's not

Starting point is 00:10:15 a single project in this ecosystem that hasn't used royalties to build. All this does is disempower smaller creators from self-starting without the massive advantages those who are funded and well-connected already have. Your faves with huge volumes, would they have capitulated to where they are without royalties? With this industry be where it is without them? They are a disruption of Web 2, a shift in value exchange that have enabled so much good. I'm disappointed this is the direction for some. Who suffers the most from this? Smaller creators, the least funded, least connected, who make up that cohort by demographic. Humza, a dev at HypSpot, rights, couldn't agree more, but sadly, most marketplaces won't care, as they've got to get those growth numbers in for

Starting point is 00:10:49 their next funding rounds, even if it comes at the cost of this entire space. Others thought that this was basically just inevitable. Haseeb, a managing partner at Dragon Fy Capital writes, Magic Eden stopped enforcing royalties, direct response to the rise of royalty-free AMM's growing market share on Solana. This seems inevitable. You might not like it, but without a market-enforceable mechanism or regulation, competition eventually leads you here. Want to keep more profits when trading? Get the best possible prices and trade with 50% lower fees on NXO Pro. The new Spot and Futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources. utilizing the complete nexo suite allows you to earn interest and borrow funds as you wait for the next trade setup.

Starting point is 00:11:36 Visit pro.nexo.io. That's p.r.0.nexo.i. and sign up today. This episode is brought to you by Circle, the sole issuer of USDC, and a leader in crypto that's held to a higher standard. USDC is a fast, safe, and efficient way to send money around the globe. USDC is always redeemable one-to-one for U.S. dollars and has over $45 billion in circulation as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations. Just go to circle.com backslash transparency to see why USDC is a trusted stable coin.

Starting point is 00:12:23 The breakdown is sponsored by FTXUS. FDXUS is the safe, regulated way to buy-ins. sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCX, you pay no gas fees. Download the FTCX app today and use Referral Code Breakdown to support the show. One countertake is that the market is reacting to two expensive royalties. King Blackboard wrote,

Starting point is 00:13:05 Unpopular Opopular Opinion, NFT creators are responsible for the current push to zero royalties. All year long, their greed kept pushing royalty rips higher and higher. Now you see the expected pushback in the other direction. In my opinion, B.A.C. had it right with their 2.5% royalties for OG Apes. Now, whatever your take, one thing that's clear is that this is partially caused by an enforceability challenge.

Starting point is 00:13:25 Jeremy Fall writes, royalties have never been fully enforceable, but that was always based off of trust and respect. Everything every single one of us is doing now is paving the way for the future of Web3. Eliminating royalties for the creators that made the space what it is today is fucking stupid. Preston Byrne, a partner at Brown Runnick says, I wonder how much OTC trading has been going on that secondary sale royalties are suddenly becoming commercially non-viable. My suspicion is that high-value NFTs and well-known media properties will still be able to command

Starting point is 00:13:50 royalties in the 200 basis point range, but new entrance to NFT markets will have a harder time. Now, one interesting place that the discussion is leading is that if this is a market structure question, are there alternatives? Beeple, obviously one of the most successful, if not the most successful NFT artist, writes, while I am obviously pro royalties and don't love what Magic Eden and others are doing, I do think there is one key change that they hit on, switching from a seller's fee to a buyer's premium. I think this is actually much more sustainable long term. Again, taking into account that royalties were actually always technically optional, it never made sense to put that on the seller. They are exiting the project and really have no incentive to pay this beyond purely goodwill towards

Starting point is 00:14:27 the creator. But by switching to a buyer's premium, they are actually very motivated to pay this as they are entering the project and creators can see if this was paid. Projects could either enable or disable metadata or utility of the NFT based on this. Creators could actually disable the NFT if this was not paid, i.e. change the image to a red X or blank image. They could also do things that are less punitive and more incentivized to offer a true premium version of the NFT for those who pay the buyer's premium. This is how auction houses do it, and I think making this switch could be an important distinction that changes the conversation around royalties to something actually technically feasible and sustainable long term. Another alternative,

Starting point is 00:15:00 that some are proposing comes from VC Kyle Simani. He writes, horizontal NFT exchanges like Magic Eden, X2Y2, and others are moving towards zero royalties for creators. On the surface, this appears to be bad for creators. Actually, I think it will become quite good. One of the biggest problems in all businesses is customer segmentation. Payment for order flow, segmented order flow by retail versus institutional, creates value for retail and destroys value for institutional. Coupons are you actually helping customers discover brand or just giving away margin. These types of questions play out in all kinds of weird ways across markets. There are, roughly speaking, two classes of participants in NFT markets. The first is

Starting point is 00:15:37 speculators, the second is non-speculators. These participants frequently have conflicting objectives. Non-speculators are roughly the types of people who care about some community and its values and what it represents. Speculators just want to make money. Obviously, the way that these people think about discovery, engagement, et cetera, are quite different. If the primary customer segment for an NFT exchange as speculators, which I'm quite confident is the case, the movement towards zero royalties creates incentives for the NFT communities to move liquidity away from generalized marketplaces to their own. As NFT communities move to their own self-hosted marketplaces, there will be many follow-on effects. A, average price per asset will decrease, as discovery fragments

Starting point is 00:16:12 and it becomes more difficult for speculator capital to effectively participate in NFT markets. B, NFT communities will produce higher signal-to-noise ratios by reducing the effect of speculators in speculative capital. C, probably creates more opportunity for NFT aggregators as asset listings fragment. D, teams like Metaplex, HoloPlex, Reservoir, and others are building out the infrastructure to make this all possible. Fingers crossed, NFT communities can use this opportunity to improve their discourse, their communities, and ultimately to fulfill their respective missions.

Starting point is 00:16:40 Now, others like Anatoly, the co-founder of Salana Labs, took this chance to discuss how protocols might evolve to actually enforce this type of royalty on chain, although left it, quote, whether users and creators will want these is yet to be seen. Still, one of the most simple and important discussions to come out of this is whether it matters for all different types of NFTs or whether there really is distinction within the field. Mike Dutas from Six Man Ventures wrote, impact of low or no royalties on some different categories of NFTs. One, profile picture low quality.

Starting point is 00:17:10 Who cares? They were all largely slow rug cash grabs, ecosystem healthier if they are starved of opportunity to benefit from gambling on shit coins with pictures. Two, profile pictures high quality with strong brand and community. Short-term revenue hit that most savvy projects already anticipated. their goal was typically to generate revenue through some combination of the following. Merchandise, lifestyle retail goods, entertainment, media IP, metaverse, community, light game, often combined with some other form of fungible token.

Starting point is 00:17:34 3. NFT gaming. Imaterial revenue impact. Model is typically to sell a higher volume of lower cost NFTs that have utility in a fun game. Primary sale revenue is what matters here and isn't impacted. Four, NFT membership slash utility. Immaterial revenue impact long term. Typically took a traditional model, pay for access to membership in an affinity club, interest group, product-related offerings such as a restaurant or other high-value goods, and attempted to improve the economics and product offering for everyone by allowing for customer buy-in ahead of time and participation in governance and structure. Ability for customers to resell membership at exit significantly better for all

Starting point is 00:18:07 stakeholders even without high royalties. Six, one-to-one human art inclusive of generative. Biggest impact in terms of long-term revenue for any individual work produced. A secondary revenue was a brand-new stream for existing artists, and it encouraged them to try out medium. However, I would argue that zero or low royalty environment still better than environment of three years ago. They still have the ability to create more art, work, and sell it into what is already a larger, more diverse, more accessible global market of buyers than before. So, let's recap. Automated royalties are one of the most disruptive aspects of NFTs for artists and creators. The market has shown that people have made a lot more from royalties than

Starting point is 00:18:41 from initial mince. But market pressures and competition are pushing NFT marketplaces to not enforce royalties. This is reminding people that royalties are not enforced on a protocol level, and are really more about social consensus and market norms. There's a lot of bluster and anger right now, but ultimately a lot of this is going to be a social market question of where norms should land. That answer might also vary by NFT category. For example, it may be that music NFTs only work in a world with protocol level enforcement of royalties, while other types of NFTs might just find different models.

Starting point is 00:19:10 All in all, to me, it feels a lot like exactly the type of discussion that the NFT space should be having during the bare market. So while it's painful, it is really an opportunity for growth as well. Anyways, I think this stuff is super interesting. It's exactly the part of NFTs that I find really fascinating. And hopefully this was interesting to you as well. For now, I want to say thanks again to my sponsors, nexo.io, circle and FTX. And thanks to you guys for listening.

Starting point is 00:19:33 Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital enterprises and asset summit or ideas. The event facilitates capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source, invest, and secure the next big deal in digital assets.

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The Breakdown - Are NFTs Still Disruptive in a Zero-Royalty World?

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