Are Optional Royalties a Bane or Boon for the NFT Space?

Welcome to Notes from the Lab. Subscribe and follow me on Twitter for more breakdowns and commentaries about all things NFT, DeFi and Web3. Thanks and glad to have you onboard!

With Magic Eden’s recent pivot to optional creator royalties, there has been much heated debate over how this impacts creators and the NFT market as a whole.

In this post, I aim to offer a balanced view to understand the motivations and impact of this change, from the lens of different stakeholders in play.

The stakeholders in question include marketplaces, creators and users.

Let’s take a deep dive.

NFT Marketplaces

Let’s start from the most obvious stakeholder: NFT marketplaces.

I believe that the motivations for marketplaces to reduce royalties stem from competition.

With other competitors doing similar moves, marketplaces like Magic Eden are seeing much less user activity and trading volume. This is simply because of users’ low barrier to exit Magic Eden and to trade on other marketplaces.

Upon this realisation, Magic Eden then followed suit to level the playing field in a bid to attract users back to the platform.

While this is an understandable tactic, I can't help but wonder if this is a rather short-sided, desperate move.

Lack of user loyalty and competitive advantages

First, it amplifies the fact that despite seeming to have a monopoly over the Solana NFT ecosystem just months ago, Magic Eden did not actually have much stickiness and user loyalty.

In fact, I’ve also just written about Magic Eden and their successes not too long ago.

Next, this also reeks of desperation from the team. ‘Price cutting’ measures like these are typically done by newcomers rather than incumbents, trying to steal market share.

For an incumbent like Magic Eden to follow suit hints that price might be their only available lever to try and win users back.

Finally, this just goes to show how fast the space moves, and how little switching costs exist.

Users can switch to a more appealing alternative in a blink of an eye, and user loyalty is extremely scarce.

Personal verdict

Marketplaces need to build their competitive advantages over time. Zero transaction fees and/or royalties are not a sustainable competitive advantage.

For a company to remain relevant for the long term, long-term brand building, user loyalty building and constant product innovation is key.

However, doing all these while navigating short-term challenges is indeed a tall order.

Creators

This is a disappointing development for creators.

One of the key benefits of using NFTs and blockchain for creators is the ability to set and receive royalties on secondary trading of their products.

This offers more power to the creators, allows them to reap the rewards of their labour, and incentivizes them to continually build over the long run.

With this race to the bottom for creator royalties, a big part of what makes NFTs appealing for creators is gone.

Argument for optional royalties: Alternative revenue sources

Supporters of optional royalties will typically point to a main argument: Alternative revenue sources.

They believe that NFT projects should not solely rely on royalties as their main revenue source and this would be unsustainable over the long run.

Instead, if we look at NFT projects like businesses, they should be using their Intellectual Property and community loyalty to build out other revenue generating products.

While this is valid, this would be less relevant for artists/creators who do not wish to create NFTs as a business. Instead they might simply view NFTs as a way to express their creativity and earn some tangible rewards, while reaching a wide international audience.

These ‘art-focused’ projects therefore have much less interest in building a business around their NFTs.

Argument against optional royalties: Rugs and scam projects

On the other hand, supporters of creator royalties also often point to another argument - that removing royalties would increase the number of rugs and scam projects in the space.

The argument is that NFT founders would have less incentive to build out a project’s roadmap over the long-term, since there is no longer a shared incentive in driving continued trading activity after the launch.

While this is also true in theory, it can be argued that such founders are not valuable in the space anyway. They have little intention of uplifting the space beyond making money, and having creator royalties might have only ‘postponed’ the eventual rug.

There will always be founders who rug, and founders who build. Zero royalties simply expose the founders who rug much earlier.

Personal verdict

Overall, I am of the belief that many creators still have greater leverage compared to the marketplaces.

If they are truly unhappy about this change, they can uproot themselves to other marketplaces and their supporters would likely follow suit.

As we have previously discussed, users have little loyalty in the space and can switch easily.

In the long run, it might be even more beneficial for projects to build their own marketplaces.

There would ideally be a Shopify-like tool for NFT creators to do so, so that they can gain full control over their projects and not be subject to the whims of marketplaces.

That being said, this also serves as a wakeup call for long-term NFT businesses: More focus should be put on generating revenue from alternative sources, rather than only focusing on the short-term trading volume and floor price.

Users

Finally, what about users like you and me?

In a competitive market like this, users typically benefit the most. We stand to benefit from the lowered fees and royalties.

Some marketplaces also run incentive-based programs to attract even more users onboard.

“Not only do you not have to pay to trade with us, we will even pay you to do so!”

State of the market

However, we need to be mindful that there might be many quality creators relying on royalties on NFTs to grow their creative practices.

Some users can and will likely still ‘tip’ optional royalties to creators whom they truly admire, but I am pessimistic about this.

We also need to be wary of alienating genuine but smaller creators from the NFT space.

Taken to the extreme, we might only see big, well-funded NFT businesses, as well as scam projects left in the space.

Conclusion

Overall, my personal stance would be that there should be money transfer where there is value transfer.

When an NFT is sold from one user to another, there will be a similar value of the NFT (art, utilities, community etc.) being transferred from the NFT creator and seller to the new buyer.

In this case, it would be reasonable for creators to ask for royalties to share the gains of their continued creative success.

Perhaps this shouldnt be a black and white decision - royalties or not. There can be customisable options for teams that choose to do new options with royalties.

Here’s a good thread detailing this:

It is also similarly reasonable for marketplaces to take a small fee, since they are offering the platform for exchange.

These fees are likely to drop over time, due to increased market competition in a bid to attract more users.

But is this sustainable? Time will tell.

Enjoyed this analysis?

Be sure to follow Notes from the Lab on Twitter and Telegram.

Feel free to drop me a DM and send any feedback, suggestions or takeaways over!