Decentralized Lawyer

Thoughts On Emerging Legal Issues At The Intersection Of Finance, Blockchain And Law​


nft royalties: Achieving a fair balance

Legal & Ethical considerations

Several major catalysts in the NFT space have spurred discussions surrounding creator royalties for NFTs. In this post, I provide background on NFT royalties, and how emerging NFT marketplaces, like Sudoswap, threaten their viability. Secondly, by using the DeGods NFT collection as an example, I provide my thoughts on the ethical and legal considerations around forcing NFT holders to sell their NFTs through royalty-based marketplaces.

1. Royalty-Free Marketplaces

Opensea, the largest NFT marketplace by volume, charges a 2.5% “Service Fee” for NFT sales on their platform. In addition, Opensea charges a “Creator Fee” which varies by collection. As I understand it, on-chain royalties allow NFT creators to tie royalties to an NFT collection. However, these can be circumvented by marketplaces choosing not to honor them or through over-the-counter NFT trades/sales without a marketplace. 

Based on my experience, most NFT collections have a creator fee set to between 2.5% – 7.5%, but I have seen collections charging up to 10% in creator fees. This can result in significant cuts to the final sale price received by the end-user, the consumer, who usually has no say in the determination of these creator fees. 

Enter Sudoswap, an NFT marketplace with several unique features which challenge the existing model of NFT royalties charged by other marketplaces. Firstly, Sudoswap is entirely royalty-free and charges just 0.5% in service fees. This is significantly cheaper than Opensea’s 2.5% and even cheaper than other decentralized marketplaces like Looksrare which charge 2% in service fees in addition to royalties.

Secondly, Sudoswap functions as an automated market maker (AMM) for NFTs, allowing NFT holders to create liquidity pools for NFTs and collect a portion of the 0.5% service fee. Not only does this result in lower floor prices for a collection compared to other marketplaces, the liquidity pool feature automatically calibrates the price of the NFTs in a pool based on supply and demand metrics. For example, with each NFT purchased from a liquidity pool, the floor price automatically rises based on the bonding curve (linear or exponential) chosen by the liquidity provider.

Technicalities aside, Sudoswap: (1) eliminates artists royalties for NFT collections; (2) generally provides a cheaper NFT purchase option to the consumer: and (3) gives liquidity providers (sellers) back a portion of the 0.5% fee that is charged on each transaction.

Several prominent marketplaces have started to follow Sudoswap’s lead. For example, Magic Eden, the largest Solana NFT marketplace, announced a decision last week to both waive its platform fees and to give users “optional royalties“, citing changing market dynamics. In this model, it is the buyer that has the option to decide whether or not to pay royalties to the creators.

2. Forced Royalties – Legal and Ethical Considerations

The DeGods NFT collection is arguably the most desirable NFT collection on the Solana blockchain, with a floor price of 256 SOL at the time of writing this post. Around early September 2022, DeGods announced an NFT mint known as “t00bs” which would be mintable for 275 $DUST tokens (approximately $550 USD at the time of mint). The team further stated that all secondary marketplace sales of t00bs would be tracked and both the buyer and seller would lose the utility associated with the t00bs NFT if they used a royalty-free marketplace (and could gain the utility again by paying back the 9.99% royalty). To their credit, DeGods has recently reversed this decision and moved to a royalty-free model on all their collections. 

There are competing ethical and legal positions both in support of and against a model of forcing holders to use royalty-based marketplaces at the risk of rosing the utility associated with their NFT. 

Arguments In Support Of Royalties

There are two key ethical arguments against the royalty-free marketplace model:

  1. Artists are unable to realize profits/royalties as their art rises in value time. Artists have historically been unable to collect royalties from their works. For example, as stated in this article, Andy Warhol’s estate would receive no royalties from the sale of two of his paintings expected to fetch $100 million at auction. According to some, the NFT model of royalties was supposed to provide a more equitable means for artists to reap the benefits from their work in the long-run as their art gains prominence.


  2. Royalty-free marketplaces disincentivize creators. According to this view, without royalties, there is little or no incentive for NFT creators/teams to develop utility for a collection, since this is generally a major source of continued revenue. In turn, this will result in NFT holders suffering because the value of their NFT will go down over time. 
In addition, I can think of two potential legal arguments in support of royalties:
  1. Ownership of NFTs is like an IP license and thus warrants royalties. A number of NFTs generally provide, in their terms of service, the right to holders of NFTs to use the art depicted in the NFT for commercial purposes (effectively, a commercial license for the duration that they hold the NFT). As such, the sale of an NFT can be seen as the sale of an IP license, warranting some sort of “kick-back” or royalty to the original creator.


  2. Utility is akin to a voidable warranty. For example, if you purchase a laptop or phone from Apple and decide to circumvent their in-house repair by going to a third party, presumably at a cheaper price, this voids the warranty on your Apple product. Similarly, holders that opt to use royalty-free marketplaces effectively “void” the utility (or warranty) tied to their NFT. Unlike voidable warranties, subsequent purchasers, as in the DeGods example, can still access the utility associated with the NFT by paying the development team back the royalties from a sale that they are owed. 

Arguments Against Royalties

There are a number of ethical arguments against the use of royalties:

  1. NFT creators generally receive a large upfront payment upon project launch. One justification for giving artists royalties, as in the Andy Warhol example above, is that art rises in value over time and an artist who sold a painting for very cheap can only enjoy the fruits of their labor by receiving royalties. However, particularly for large generative projects, NFT creators can make a substantial sum of money up-front, which effectively compensates creators for potential future growth in value of their art. This upfront payment can also be seen as akin to a funding round, providing the team with what they need to develop the utility of the NFT.


  2. What about teams that are not actually creating utility? If the justification for giving artists royalties is to help them realize profits as the value of their art increases, what about the remaining (majority) of NFT collections that effectively go to 0? Closely related to this argument is one where teams continue to put out announcements that they are “building” but are not developing any utility at all. In many cases, NFT teams continue to enjoy royalties on products for which they are doing little to not development work, including projects that are outright rug-pulls. In this case, the consumer suffers because they pay royalties not only for sales of their “winners” but also their losers. 
In addition to this, a few legal positions may be reasonably taken against forced royalties:
  1. Restraint on alienation. This is a principle in common law stating that one cannot have “absolute” ownership over their property if there are restrictions on what they can do with it. For example, in the estates context, a term in a will that says “I give my child this house but they cannot sell it” is void because one cannot give a gift absolutely and also put conditions on what someone can do with that gift.


  2. First-sale doctrine. Related to restraint on alienation, but specific to the intellectual property (IP) context, the first sale-doctrine limits the right of the IP owner to control the resale of their product. For example, in the Lexmark decision, the United States Supreme Court stated:


    Once a patentee sells an item, it has secured that reward, and the patent laws provide no basis for restraining the use and enjoyment of the product.” However, the Court also states “If the patentee negotiates a contract restricting the purchaser’s right to use or resell the item, it may be able to enforce that restriction as a matter of contract law”.

    There are a few things to note. Firstly, the Lexmark decision involves a dispute between two commercial parties and not a consumer. Secondly, even if royalties are built into the code (“code is law”), it does not mean that they will be enforceable as a matter of contract law, particularly if the contract is deemed to be anti-consumer protection. These considerations likely favor the right of a consumer to sell their NFT in any marketplace they choose.  

3. Proposed Solutions

I find it unlikely that courts would enforce NFT royalties in a consumer context, particularly because it goes against fundamental principles of ownership and because it is, in my opinion, likely anti-consumer protection. There are some proposed solutions which I believe are both legally sound and ethically justifiable. 

One option is for the development team to hold back a certain number of NFTs for themselves during the mint. This would incentivize the team to continue to build the project so the NFT collection rises in value. The team could, at fixed intervals, sell some of their NFTs, which would then effectively function as a payment for work done.

A second option, if the NFT is to be treated like a membership granting utility, is to create an Ethereum Name Service (ENS)-like model. In this system, buyers would purchase NFTs for a certain period of time and could extend their ownership of that NFT at some expiry date. The team would be incentivized to continue to develop utility for the project because doing so would mean holders would be more likely to “renew” the NFT, thus resulting in continued revenue for the developers.

I believe either of these options would achieve a fair balance between consumer protection rights while providing a continued stream of income for the NFT creators without the need for royalties. 

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