NFT Royalties: Their Purpose and Mechanics for Creators
Recently, NFT royalties have been in the industry's spotlight. While they provide creators consistent income from secondary markets, those same marketplaces are battling over its existence.
Apr 13, 2023
NFT royalties have been in crypto's spotlight recently. Marketplaces are battling over allowing secondary market sales to creators (and for how much).
Some platforms have even taken this opportunity to boost trading activity with zero fees and optional NFT royalties. Conversely, others have continued to honor royalty payouts, ensuring fair compensation to creators.
But what are NFT royalties in the first place? Let's explore their purpose and mechanics which have been at the center of this conflict.
What Are NFT Royalties?
NFT royalties provide creators a percentage of the sale price each time their digital collectibles are resold on the secondary market. Their purpose is the same as in the music and film industries: to compensate creators for their work and provide a regular revenue stream.
Deducted from sellers' revenue on the secondary market, NFT royalty percentages can range anywhere between 0% and 10% on most marketplaces. Rarible is considered an outlier, as it allows creators to set a maximum 50% fee for secondary sales of their work.
How Can Creators Benefit From NFT Royalties?
Besides offering users complete and verifiable ownership via the blockchain, the purpose behind non-fungible tokens is provide fair compensation to creators. NFT royalties play a critical part in accomplishing this goal.
As we know, the initial sale of NFT collections provides creators with a one-time payment. However, the royalties from these secondary market transactions allow the creator to generate passive revenue from their work. This opportunity allows creators to benefit from a project's future success as the value of their NFTs increase.
For example, BAYC's Bored Ape #7537 was sold initially for $229 (0.08 ETH) in May 2021. Just over a year later, a buyer purchased the same NFT for over $1.22 million. In doing so, Yuga Labs earned approximately $30.5k from their 2.5% royalty in the transaction.
This shows not only the power of creator royalties, but also illustrates how creators can earn future income after possibly underpricing its initial sale.
In hindsight, royalty payments would have helped past creators like Harvey Ball. Ball received only $45 for the smiley symbol's original design which later became a global licensing empire worth over $500 million annually.
Therefore, NFT projects can use royalties to attract talented creators by offering them meaningful compensation. At the same time, royalties incentivize high-quality work from these creators (as unique artwork can boost reselling activity and generate more secondary market revenue).
How Do NFT Royalties Work?
Now that we explored what NFT royalties are, and their benefits, it's time to dive deeper into their mechanics. The first step is to understand who participates in the transaction.
Participants of the Transaction
The first party is the creator (project) who mints, lists, and sells a non-fungible token to its first owner via a marketplace. It's up to the creator to determine the NFT royalty percentage (or whether to take a cut from secondary sales at all). In most cases, the same rate applies to all items in a collection, but a few marketplaces allow creators to set different royalty fees for individual collectibles.
The next participant is the seller who lists and sells the original NFT on the secondary market. While the transaction between the NFT’s creator and first owner is not subject to any royalty fees, the creator still takes a cut from all trades occurring after the initial sale.
Besides the creator and the seller, most royalties have a third participant: marketplaces.
As it can't be enforced on the blockchain, the marketplace is the party that operates the smart contract. They are responsible for automatically deducting royalties from the seller's revenue and distributing it to the creator. The payout sum is based on the value of the transaction and the NFT royalty percentage.
The Role of Marketplaces
While transactions occur between creators and secondary market sellers, marketplaces play a crucial role as they enforce the policies. And that's why NFT royalties may work differently on various services.
For example, some marketplaces immediately distribute royalty payouts to creators' wallets while others make periodic payments. Some creators receive protocol fees instead of royalties like on LooksRare. Meanwhile, some marketplace buyers decide whether to compensate creators like on Magic Eden.
It's also the marketplace's discretion to allow creators to transfer royalty policies across different platforms.
For instance, the ongoing battle between OpenSea and Blur makes it difficult for creators to sell an NFT via one service and receive payouts from secondary sales on the other.
The Battle Over NFT Royalty Fees
In the last few months, NFT marketplaces have been waging war against each other.
The conflict first broke out in August 2022 when Sudoswap introduced 0% royalties for its automated market maker (AMM).
As a result of the bold move, it only took a few weeks for the platform's trading volume and TVL to increase exponentially. Consequently, more marketplaces have followed suit to implement zero-fee collectibles or optional creator royalties to attract more users. In contrast, other platforms have doubled down on providing fair compensation to NFT creators for their work.
Interestingly, this entire battle was possible as creator payouts aren’t enforceable on chain and therefore neither are the associated NFT smart contracts. For that reason, they have to be enforced on the marketplaces themselves.
This means that platforms like OpenSea, Blur, and Sudoswap have the authority to decide whether to compensate creators for secondary market sales. And that's why some have taken advantage to boost their trading activity with zero or optional NFT royalties.
How Are NFT Royalties Taxed?
Creating an NFT is not a taxable event in itself. However, creators will pay tax when their collectibles start earning revenue, which includes the initial sale and NFT royalty payouts.
A taxable event is created every time a creator receives a royalty payment from secondary market sales. In general, creators have to pay both a regular income tax and a self-employment tax on royalties if they have minted their NFTs as part of their profession or business.
That said, regulations vary by jurisdiction so it's critical to check your corporate tax laws to ensure compliance.
How to Calculate and Pay Royalties?
NFT projects regularly send royalty payouts to their creators, making accuracy essential in revenue categorization and calculation.
Generally, an NFT's royalties are calculated as a percentage of the sales price. The creator sets this value, with the average NFT royalty fee ranging between 5% and 10%.
When it comes to categorizing your royalties at scale, Integral makes it possible with NFT accounting. You can automatically categorize by collection, non-fungible token, and marketplace with intuitive rule creation at 99% classification accuracy.
With Integral, NFT creators also have real-time visibility into their primary and secondary sales, so they can clearly see their associated payment breakdowns. We plan to introduce creator payouts in the future so you can quickly send those outstanding payments with a single click.
Integral manages your whole NFT inventory and their associated transactions in one place. With that time saved, NFT creators can uncover strategic opportunities and less time in manually reviewing Etherscan.
Looking for control in managing your NFT royalties? Book a demo with us and our team will show you how quickly it can be done.