What Are NFT Royalties & How Do They Work?
Key Takeaways
- NFT royalties are a solid way for artists to earn passive income
- They are set during the minting stage
- NFT royalty percentages are generally between 2-10%
- Some marketplaces have royalty fees lower than 1%. Some have none
What Are NFT Royalties?
Non-fungible token (NFT) royalties, or NFT royalties, are fees that are paid to the original creator of the NFT in exchange for the use of that creator’s property. In other words, it’s a way for the NFT artist to bring in money after the initial sale, paid for by the buyer. Pretty sweet deal for the artist as it can result in a potentially never-ending stream of income off the back of a single digital asset. For the top NFT collections, this means millions.
To give a real-world analogy, imagine you write an absolute banger of a song. You record it, produce it, and sell it to a major label. You receive a windfall of cash for your genius. Because it’s so good, the major label promotes it everywhere. The track receives significant airtime and is sold to Google because they want to use it in a commercial. You get paid every time your track is sold or played.
To make it even simpler, it’s like winning the lottery and being given the option of taking an initial lump sum or a payout over time—and choosing both.
How Do NFT Royalty Fees Work?
Sometimes, blockchain-based interactions can be extremely convoluted. Fortunately, NFT royalties are pretty simple. They are set in place during the minting phase of creation when the digital asset creator mints their product and lists it on a marketplace. The creator chooses their royalty percentage and payout wallet, and, well, that’s basically it.
Once the NFT is resold to a secondary buyer, the original artist receives that royalty payout, which generally varies between 2-10%. The platform will usually take the same percentage as the artist as a “royalty fee.” This is taken from the buyer and won’t affect the price the seller receives.
The artist minting the NFT is the one who decides which royalty percentage to add to the contract. This is decided upfront and is applied during the minting stage. Those with more profitable collections or pieces can afford to lower their royalty percentages to incentivize trading.
NFT royalties are tracked on-chain with the use of smart contracts. Smart contracts facilitate the terms of an execution of an agreement (in this case, the sale of the NFT). It makes sure the creator receives their royalty percentage and is performed automatically. Smart contracts are probably the easiest way to guarantee royalties are paid.
How Are NFT Royalty Percentages Added?
Royalties can be added to NFTs in one of two ways. If the artist mints their NFT on a platform that automatically adds a certain royalty percentage, it would be embedded in the smart contract. In this instance, the artist won’t need to custom code the contract, as the minting platform already did it.
The second way a royalty contract is added is when the artist adds a custom contract to an NFT on the NFT marketplace. This generally allows the artist to choose their own royalty percentage, which is often lower than when the NFT platform chooses one for you.
There is a standardized NFT royalty system that applies to ERC-712 (there’s now ERC721-C that gives NFT creators even more control) and ERC-1155 interfaces. ERC-2981 is a standard that signals to other interfaces which royalty percentage should be sent and to where.
Before this was finalized/implemented in 2021, there was no real way for marketplaces to communicate royalty percentages. Some older collections don’t use it because they were minted and have been in circulation since before ERC-2981. Think CryptoPunks.
How Royalties Are Calculated
Since the smart contract says how much the artist will be receiving as a percentage of the sale, it’s super simple how NFT royalties are calculated. In some of the most basic math ever, when a sale occurs, the percentage is taken from the sale.
If the artist mints their NFT with a royalty percentage of 5%, and the NFT sells for 3 ETH, you would calculate what 5% of 3 ETH is, which is 0.15 ETH.
3 x 0.05 = 0.15.
That’s the artist’s royalty, which is sent to their wallet when the NFT is sold.
NFT Royalty Fee Example
Here’s a more thorough example: Jack the Artist mints an NFT on Blur (nice). When Jack mints it, he adds a custom contract with a 0.5% royalty fee because Jack isn’t greedy and that’s the minimum anyway. Jack the Artist mints a pretty rad NFT titled “Jack the Artist.” It sells nearly immediately for a wonderful 12 ETH. Classic Jack.
Before Jack the Artist gets paid for “Jack the Artist,” the marketplace registers the sale. Since Blur offers no-fee trading (as a way to lure traders away from OpenSea), the chain reserves Jack’s royalty from the sale price. Remember, that’s 0.5% of 12 ETH. So using the same math as above:
12 x 0.005 = 0.06 ETH. Jack just made 0.06 ETH, deposited right into his specified wallet. Nice.
Benefits Of Royalties For Creators
The only real drawback to creators is when they choose too high a percentage and may lose a buyer because of it.
Benefits include:
- Income every time their work is sold
- Which translates into long-term passive income
- Which allows the artist to continue minting new pieces
- While developing a record of income production
NFT royalties can be a major source of income for artists and should be implemented in a strategic way when it makes sense, which is often.
List Of NFT Marketplaces With Royalties
Royalties are great—but not every marketplace has them. That’s unfortunate for the seller as it favors the buyer, and is clearly the marketplace favoring traders over artists. However, there’s been a move to enact minimum royalty fees, which is cool. Here’s a list of marketplaces still using royalty fees, and whether or not they enforce them:
1. OpenSea
- Currently no fees
- Optional creator earnings: 0.5% minimum
- Not enforced if tradable on Blur.
- Enforced fully if not also trading on Blur.
2. Blur
- Currently no fees
- Minimum 0.5% royalty
- Enforced fully if not also trading on OpenSea.
- Enforced minimum 0.5% if also tradable on OpenSea.
These are the two largest exchanges and, as you can clearly see, hate each other. Some other marketplaces include:
3. Rarible
- 1% taken from both the buyer and seller side of a transaction
- Enforced through aggregation from other marketplaces and Rarible’s community marketplaces.
4. SuperRare
- Primary sales have a 15% fee taken from the artist’s payout
- Secondary sales take 10%
- All sales take 3% as a marketplace fee, paid for by the buyer
- Enforced fully.
5. Magic Eden
- Flat 2% transaction fee
- Enforced fully.
Optional royalty fees exist when a marketplace leaves it up to the buyer whether they will honor the royalty fee. As you can guess, many buyers won’t honor the fee, and this leaves the artist in the lurch. The implementation of optional fees increases liquidity for sure, but it isn’t exactly enticing as a seller to list your NFT on a marketplace that won’t back you up.
NFT Royalties Laws & Taxes
NFT royalties provide ongoing income for artists with every new sale. Income is the key word here. That means NFT royalties are taxable as ordinary income (reported on Schedule E). Depending on your tax bracket, you might pay up to 37% in federal income taxes if you had a great year, or a lesser percentage if your total income was lower.
The initial sale of the NFT works differently, however, and the tax treatment depends on whether you’re a hobbyist or you sell NFTs as a business.
- As an NFT hobbyist, your crypto minting costs become your cost basis. When you sell the NFT the profit between your cost basis and the sales price is taxed as capital gains.
- When selling NFTs as a business, sales of NFTs you minted are treated as ordinary income, just like if you sold any other type of artwork you create. (NFTs you buy from others and then sell become capital gains or losses.)
To Sum It Up
NFT royalties are an elegant way for artists to get paid every time their art is sold, provided it’s done so on an exchange that enforces royalties. The calculations are performed within smart contracts and result in a payout to the artist’s wallet once their NFT experiences a secondary sale. However, with the recent “race-to-the-bottom” mentality of marketplaces slashing fees for creators, royalty payment percentages are diminishing at an alarming rate.
Frequently Asked Questions
NFTs typically have royalties ranging from 5% to 10%, although many top projects are at 5%. However, not all marketplaces enforce royalties. Smart contracts allow NFT creators to build a royalty payment for secondary sales so that each time the NFT is sold you get a percentage of of the sale. The bad news is that these smart contracts aren’t fully enforceable.
Yuga Labs has earned the most in royalty fees. Royalty earnings are driven by trading volume moreso than percentages. Due to its popular collections like Bored Ape Yacht Club (BAYC), Yuga has collected nearly $150 million in royalties as of late 2022. Yuga’s BAYC, as an older collection, has a 2.5% royalty fee, but its newer collections like Otherdeed carry a 5% royalty fee.
If you, as a creator, mint an NFT and add a smart contract that specifies a royalty percentage and that NFT is listed on a marketplace that enforces royalty payments, and the NFT sells, then yes, you would receive a royalty. However, there seems to be a race-to-the-bottom mentality among marketplaces as they jockey to secure the most active NFT traders. In order to incentivize those traders, some have enacted optional creator royalty fees. Good for the trader, bad for the creator.
Royalties are recurring revenue for in-demand projects. As an example, the initial sales of Bored Ape Yacht Club (BAYC) brought $2.2 million in revenue. Subsequent sales to traders and collectors brought 24 times the amount of revenue, netting $54 million in royalties for the collection. Royalties are set at just 2.5%, half that of newer collections.
Using BAYC as an example, the key to making money with NFT royalties isn’t necessarily tied to higher royalty percentages, but rather to creating in-demand collections that generate excitement and added trading volume. Each new trade is an opportunity to earn more royalties.
Good news for the artist—the buyer pays the royalty fee. Well, to be technical, the marketplace pays the fee, but they are just a pass-through entity. The marketplace takes the royalty fee—let’s say 3%—from the buyer and “passes” 3% to the original creator once the NFT is sold.
Smart contracts are used to facilitate royalty payments when an NFT is sold. If an NFT is sold, the contract executes the royalty provision. Marketplaces take this percentage upfront so that when an NFT is sold on their platform, they have replaced the royalty payment taken out of their cut of the sale. Once the smart contract is triggered and the funds are released, the blockchain is updated to reflect the execution of the contract. Many marketplaces will provide these sales contracts, so you won’t have to code your own.
Short answer—no, you can’t transfer royalties. The creator needs to keep in mind their royalty percentage and their inability to have much sway, if any, over marketplace royalty policies when they mint their NFT. Many artists agree that marketplaces not enforcing royalties is a “bad move” and either will stop doing business with them or do what they can to encourage buyers to honor those contracts.
