NFTs have a royalty problem: Here’s the answer

The nonfungible token (NFT) trend is still screaming hot like an overheating car engine, with renowned celebrities, influencers, artists, musicians and creators alike jumping on the bandwagon to capitalize on these new digital assets. From a diverse range of NFTs changing hands for tens of millions of dollars to the ever-expanding list of secondary marketplaces, the NFT ecosystem is understandably turning heads.

But amid all of this, there’s a lingering problem that often goes unnoticed.

NFT proponents claim that the underlying smart contracts are designed to give creators more control and power over their content. They claim that these smart contracts can help artists establish royalties for their NFTs, ensuring that every time the NFT changes hands, the original creator receives their fair share of the revenue.

The NFT royalty structure

Even though the concept sounds great on paper, things work out differently in the real world. Pointing out the technical loophole with NFT royalties, Jeff Gluck, CEO of CXIP Labs, notes, “The problem with the current NFT royalty structure is that marketplaces are not designed to be cross-market compatible. The smart contracts are unable to communicate with each other when it comes to royalty triggering events across the ecosystem.”

To delve deeper into Jeff’s perspective, it is critical to acknowledge that most NFT tokens are ERC-721-based. Therefore, when an artist first sells their work to a buyer, they are entitled to receive the proceeds from the initial sale. If the buyer then goes to a secondary market like Rarible to flip the NFT for two, three, five, or ten times the original price, the artist never sees any remuneration in the form of royalties from subsequent sales.

There is no denying that NFTs have immense potential to disintermediate the prevailing publishing model and empower creators simultaneously, especially when considering royalties accrued from these creative works are probably the most powerful incentives driving motivation and commitment. 

However, the prevailing problem with today’s NFTs is that the creator’s royalty is tied to the marketplace where the NFT was originally minted. The creator can’t prevent a buyer from listing their NFT on other, competing marketplaces. As a result, there is a stark possibility that the original creator will miss out on any royalties generated from subsequent sales.

If this wasn’t a serious problem already, consider for a second that buyers often opt for private sales to avoid high transaction fees. In this case, NFTs are directly transferred from the seller’s wallet to the new buyer’s wallet, effectively cutting out the creator and any corresponding marketplace from the entire process.

Universal token standards

The NFT ecosystem’s obvious answer for keeping creators incentivized is a universal token standard accepted across marketplaces. This will ensure that the royalties stemming from a body of work will always be shared with the creator, irrespective of the marketplace or blockchain where subsequent transactions unfold. 

Still, given the stiff competition between NFT marketplaces and the ongoing battle for dominance playing out between first and third-generation blockchains, establishing a lasting, agreeable standard among these parties will likely prove elusive. 

The other, more likely avenue for addressing this royalty mismatch lies in the capabilities of smart contracts. As underlying NFT technology evolves and new novel use cases are unlocked, smart contracts can facilitate newer transaction types, like subscriptions, while also ensuring that royalties from all future sales are passed along to the creator in perpetuity.

There is progress being made on this front, albeit quietly. The ERC-721 standard that laid the foundation of NFTs is undergoing continuous revisions to enable more dynamic standards for paying out royalties.

The NFT ecosystem is undeniably still at an early stage, despite its near parabolic growth and staggering sums being spent. As such, there is a lot of room for improvement, especially when it comes to platforms and initiatives that focus on implementing solutions that will fairly compensate creators for their contributions in perpetuity.

Sadie Williamson is the founder of Williamson Fintech Consulting.