With the emergence of Bitcoin ordinals, and their supposed incompatibility with NFT royalties, it’s worthwhile to review:
- What NFT royalties are
- How they work
- Their benefits and downsides.
This topic is important because whether you’re an artist or an investor of digital art, each Blockchain’s royalty payments could determine whether or not to invest your time and money in it. For example, Bitcoin is fundamentally incompatible with royalties, while Ethereum isn’t. Does that make Ethereum a more attractive blockchain for investors, artists and content creators? Not necessarily.
This article explains the nuances of NFT royalties in more detail, and how bitcoin ordinals treat them.
What are NFT royalties?
NFT (non fungible tokens) royalties are mechanisms allowing NFT creators to earn royalty percentage on secondary sales across NFT marketplaces. An NFT royalty provides a continuous income stream for creators and gives them control over their art.
How do NFT royalties work?
NFT royalties work via smart contracts, which are self-executing agreements. So when terms and conditions are met, they are enforced on the exchanges.
Once a piece of digital art or a digital artwork is created, the NFT artist can establish a smart contract with a royalty agreement to their preferences (between usually 5-15% of the sale price). When the NFT is sold, the smart contract automatically executes and sends the royalty amount to the creator’s digital wallet. The payment is typically made in cryptocurrency, like ethereum.
The entire transaction is transparent and automated, ensuring timely payments and eliminating manual interventions and intermediaries.
What are the benefits of NFT royalty payments?
The following are the benefits of NFT royalty payments:
1. Continuous revenue for creators
NFT royalties provide artists with an ongoing income stream. This serves as recognition of their original work, and ensures their compensation. This supports their current works that are in development and incentivizes them to keep producing high-quality content.
2. Value distribution for all parties
The royalty system helps distribute value more fairly within the NFT ecosystem. This is achieved through creators, collectors, speculators, and platforms all profiting from NFT trades in different amounts.
3. Enhanced value proposition
Royalties incentivize creators to promote their work and remain engaged with their audience. This can increase the value of their existing collections which are in owners’ hands. The increased desirability can lead to higher resale prices.
NFT owners and creators are part of the same ecosystem. So a thriving market with an active creator community, propelled on by royalties by part, can increase the overall value of the NFT space. Owners’ individual NFTs can indirectly benefit from reputation and value growth of the NFT market.
5. Encouraging authentic and scarce works
Royalties are tied to market demand that rewards and appreciates originality. So creators are more likely to benefit from the resale of unique, limited edition works. The implication is creators creating catalogs of distinctive, rare digital art, enhancing the value of NFTs held by collectors.
What are the negatives of NFT royalties?
The downsides of an NFT royalty system include:
1. Unclear royalty terms
NFTs’ royalties terms can vary. And it can be to the owner and creator’s detriment if they are unfamiliar with it. For example, Superare, a marketplace of luxury digital art, gives collectors 90% and creators 10% on secondary sales. But on Binance Smart Chain, the value is on a spectrum of 0-10%. And this year, X2Y2 and Magic Eden have opted to make royalty payments optional, and its inclusion in trade a case-by-case matter between the buyer and the seller.
The lack of consistency across blockchains can lead to over/underestimation of royalty calculation.
2. Platform limitations
Not all platforms, or side-chains, support automatic royalty payments or royalty standards, like ERC-1155 on Ethereum. Incompatible payment mechanisms can lead to confusion and potential disputes if the NFT is created on one blockchain and sold on another one that doesn’t support royalties.
We weren’t able to find any real-life scenario of such an incident. But theoretically, an artist could transfer an NFT from one blockchain to another through bridging services or wrapped tokens, only for the new blockchain to not recognize/support the royalty mechanisms of the original blockchain.
3. Tax implications
Gains from NFT sales may be taxable, depending on the jurisdiction. This can complicate the financial aspects of NFT sales, as buyers and sellers need to understand and comply with applicable tax laws and reporting requirements.
4. Smart contracts’ vulnerabilities
Smart contracts can have vulnerabilities or errors, such as integer arithmetic, that could lead to disputes or incorrect royalty distribution.
5. Price manipulation & wash trading
Market players could try and manipulate the NFT market by wash trading or artificially inflating the value of an NFT, ultimately affecting royalty revenue. This can result in mistrust and confusion in the market.
6. Ethical concerns
Some NFT creators may use royalties as a way to profit from controversial or objectionable content, which could dissuade potential buyers from purchasing the NFT.
7. Decreased liquidity
NFTs and cryptocurrencies are meant to be decentralized and permission-less. Having to pay royalties, or abiding by a royalty policy, complicates a sale and slows the turn around speed.
How do Bitcoin Ordinals address creator royalties?
Bitcoin ordinals (i.e. ordinal inscriptions) are minted on satoshis and stored on Bitcoin. To create ordinal inscriptions, you can leverage no-code inscription tools.
Bitcoin ordinals natively do not support royalties because they leverage the Bitcoin blockchain. The reasons why Bitcoin cannot natively support royalties include, but aren’t limited to:
- Limited scripting language: Bitcoin’s scripting language is limited in functionality than more advanced languages like Ethereum’s Solidity. This makes it difficult to implement complex logic, like royalty distribution, via smart contracts.
- Scalability: Bitcoin’s limited transaction throughput and slow confirmation times can make it unsuitable for handling a high volume of NFT transactions, which would be necessary for managing and distributing creator royalties efficiently.
For more on NFTs and Ordinal Inscriptions
To learn more about NFTs and Ordinal Inscriptions, read:
Cem has been the principal analyst at AIMultiple since 2017. AIMultiple informs hundreds of thousands of businesses (as per similarWeb) including 60% of Fortune 500 every month.
Cem's work has been cited by leading global publications including Business Insider, Forbes, Washington Post, global firms like Deloitte, HPE, NGOs like World Economic Forum and supranational organizations like European Commission. You can see more reputable companies and media that referenced AIMultiple.
Throughout his career, Cem served as a tech consultant, tech buyer and tech entrepreneur. He advised businesses on their enterprise software, automation, cloud, AI / ML and other technology related decisions at McKinsey & Company and Altman Solon for more than a decade. He also published a McKinsey report on digitalization.
He led technology strategy and procurement of a telco while reporting to the CEO. He has also led commercial growth of deep tech company Hypatos that reached a 7 digit annual recurring revenue and a 9 digit valuation from 0 within 2 years. Cem's work in Hypatos was covered by leading technology publications like TechCrunch and Business Insider.
Cem regularly speaks at international technology conferences. He graduated from Bogazici University as a computer engineer and holds an MBA from Columbia Business School.
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