Non-fungible tokens (NFTs) have sparked a revolution in how we think about digital and physical asset ownership. A key aspect of NFTs is their ability to generate royalties—payments that flow to the creators or owners whenever their NFT is resold. This system offers creators long-term financial benefits while changing how intellectual property (IP) is valued, particularly in secondary markets. In “How NFT Royalties Work”, Scott Duke Kominers, Principle Investigator at D^3’s Crypto, Fintech, & Web3 Lab, along with authors Michael Blau and Daren Matsuoka, explore how NFT royalties function, the challenges they face, and their implications for creators, marketplaces, buyers, and sellers (individuals and businesses) using crypto marketplaces.
Key Insight: Understanding NFT Royalties
“While anyone can verify ownership of an NFT on a public blockchain, existing royalty designs restrict which wallets and smart contracts are allowed to execute a transfer or own the NFT in the first place.” [1]
NFT royalties refer to the payment creators earn from secondary sales of their work, enabled by smart contracts on a blockchain. Traditionally, creators only earn a one-time payment when they sell their creations. NFTs embed royalties into smart contracts, allowing creators to earn a percentage of the resale value each time their NFT is sold in the secondary market. A key factor in the appeal of NFTs is composability, which refers to the ability for NFTs and decentralized applications to interact seamlessly across different platforms. Although the composability of NFTs allow them to be traded and used in a variety of marketplaces and applications, it introduces challenges for enforcing royalties.
Key Insight: Blocklists vs Allowlists
“Creators face a significant tradeoff no matter which design they use, depending on how their NFT smart contract implements transfer ‘preventions’: The more strictly the creator prevents transfers, the less composable the NFT.” [2]
Enforcing NFT royalties is inconsistent across platforms, with some marketplaces bypassing royalty payments altogether. This presents a challenge for creators and marketplaces, as they must navigate different approaches to enforcing royalties while maintaining the flexibility that make NFTs attractive. Two methods for addressing this issue are blocklists and allowlists:
- Blocklists offer enforcement by restricting non-compliant wallets or platforms from trading NFTs. However, “bad actors” can still get around blocklists by creating new royalty-circumventing marketplaces that are not on the blocklist. Additionally, blocklists can only stop royalty circumvention by placing marketplaces that circumvent royalties on a blocklist after they’ve been discovered.
- Allowlists ensure royalties are paid by restricting NFT trading to specific compliant platforms. However there are downsides to allowlists; allowlists can be restrictive and constrain composability, as they require creators to approve each application that wants to facilitate an NFT transfer, as well as which wallets can own an NFT. Additionally there are ways buyers can circumvent royalties even when using an approved marketplace such as making an agreement with a seller to purchase an NFT for $0 on the marketplace, but paying the seller in another application.
Key Insight: The Staking Model
“Introducing a staking model for allowlist membership would permit new applications to optimistically add themselves to the allowlist by staking money or other resources as a commitment to enforce royalties” [3]
One approach the authors propose to enforce royalties is using the staking model. This model requires marketplaces and other applications to stake assets to gain access to royalty-compliant platforms. This financial commitment helps ensure that royalty payments are upheld when NFTs are resold.
Although the staking model enables marketplaces to acquire allowlist membership without needing approval, the authors posed several open questions to take into consideration when applying the model: How would creators implement the arbitration of slashing? Who should get the slashed stake? What should be the size of the stake? And should stakes be aggregated across multiple NFTs?
Key Insight: The Right of Reclaim Mechanism
“With the right of reclaim mechanism, if the asset and title owner of an NFT differ […] then the title owner can always reclaim the NFT to their wallet at any time.” [4]
The authors also propose the right of reclaim as a mechanism to incentivize royalty payments without restricting composability. Under this framework, buyers of NFTs gain ownership of the asset but not full control of its title until the royalty is paid. If the royalty is not honored during resale, the last title holder has the right to reclaim the NFT.
The right of reclaim encourages buyers to pay the title transfer fee (the new “royalty”) during sales to avoid losing the NFT. For businesses and creators, this mechanism offers a solution to the problem of enforcing royalties. However, for buyers, it introduces the risk of an owner reclaiming the title for their NFT.
Why This Matters
NFT royalties are not just for artists or collectors; they represent a shift in how both digital and physical assets can be monetized. C-suite executives in entertainment and media, gaming, sports, and even real estate industries must learn how to navigate digital marketplaces, as NFTs are transforming how property ownership is transferred and managed. Understanding how NFT marketplaces can overcome the challenges with enforcing royalties will be crucial for creating revenue streams with both physical and digital goods, as well as other intellectual properties.
References
[1] Michael Blau, Scott Duke Kominers, and Daren Matsuoka, “How NFT Royalties Work: Designs, Challenges, and New Ideas”, a16z crypto (June 26, 2024), https://a16zcrypto.com/posts/article/how-nft-royalties-work/.
[2] Blau, Kominers, and Matsuoka, “How NFT Royalties Work: Designs, Challenges, and New Ideas”, https://a16zcrypto.com/posts/article/how-nft-royalties-work/.
[3] Blau, Kominers, and Matsuoka, “How NFT Royalties Work: Designs, Challenges, and New Ideas”,https://a16zcrypto.com/posts/article/how-nft-royalties-work/.
[4] Blau, Kominers, and Matsuoka, “How NFT Royalties Work: Designs, Challenges, and New Ideas”, https://a16zcrypto.com/posts/article/how-nft-royalties-work/.
Meet the Authors
Michael Blau is a partner on the a16z crypto investment team. Prior to joining a16z crypto, Michael was an analyst in BlackRock’s Portfolio Analytics Group. He graduated Magna Cum Laude from Washington University in St. Louis with a finance and computer science degree. Michael is an NFT creator under the alias x0r and a magician with experience working for David Blaine and performing at The World Famous Magic Castle in LA.
Scott Duke Kominers is a Professor of Business Administration in the Entrepreneurial Management Unit, Co-Principal Investigator of D^3’s Crypto, Fintech and Web3 Lab, a Faculty Affiliate of the Harvard Department of Economics and of the Harvard Center of Mathematical Sciences and Applications. His first book is The Everything Token: How NFTs and Web3 Will Transform the Way We Buy, Sell, and Create.
Daren Matsuoka is a partner on the crypto investment team at a16z, where he supports deal flow and portfolio companies by extracting data from public blockchains. Prior to a16z, Daren was a Data Scientist at SVB Capital where he developed and managed a proprietary data and analytics platform. Before that, he completed financial training programs at Morgan Stanley and State Street. Daren holds a B.S. in Economics and Computer Science from UC Davis.