NFT Royalty Structure

The ability to support royalty payments is a clear and enticing feature of Non-Fungible Tokens (NFTs). NFT royalty payments are permanent and are executed automatically using smart contracts. If a royalty rate is set, the smart contract ensures that the terms of the NFT is fulfilled and the original owner of this digital asset is paid a percentage of the sale price. It is not uncommon for marketplaces to allow artistes determine their royalty percentages at the time of minting the work.

For example, if an artist creates an artwork and mints it on OpenSea, a fan of the artwork can purchase same for 2ETH (depending on the bids on the artwork the timeline to receive same). The creator of the art earns 2ETH. At the point of minting the artwork as an NFT, the smart contract may contain a term that states that if and when secondary sale occurs, the artiste receives 10% of the revenues. (depending on the terms of use of the marketplace). If the smart contract is setup this way, the royalties begin with each resale. With NFTs royalties, artists earn from every sale of their work for as long as it sells.

EIP 2981

EIP-2981 is an open royalty standard that communicates to players in NFTs marketplaces, the royalty payment information for a specific NFT or collection of NFTs.

Before the implementation of this standard, an open royalty payment standard did not exist in NFTs marketplaces. Generally, with NFT standards (ERC-721/ERC-1155), marketplaces have been able to easily transfer ownership of NFTs between different collectors at every point of sale. However, because information regarding royalties is retained by these marketplaces and was often not shared, an NFT may be taken off a marketplace and then sold in another, and the creator of the NFT would not earn the royalties that they are entitled to.

Here is why;

The sale of an NFT on a marketplace is executed upon the completion of these two actions:

1. The buyer transfer funds to the seller.

2. The seller transfers the NFT to the buyer.

As the only one who can validate the terms of sale, the market place would ensure that the amount to be paid for the NFT and the NFT to be sold is agreed by the parties. Hence, the marketplace is the one in charge and in the know of the proportion of funds to be distributed to the NFT creator as royalties. Also, pre-existing NFT smart contracts (ERC-721/ERC-1155) could not determine whether a simple transfer of an NFT from an address to another was a mere transfer or an actual sale.

Rationale for EIP-2981

There are a few reasons for the adoption of a standardized solution for sharing information about the royalties to be paid out when a sale is made on an NFT. One of such is to ensure that when onward sales are made on an NFT, the royalties that accrue to the creator on that particular NFT or collection of NFTs are made to a single payment address that belongs to the creator. Prior to the adoption of EIP-2981, when the onward/secondary sale of an NFT is to be executed on a different platform, the ERC721/1155 standards could not enforce payment of royalties as information on what amount to be paid to be as royalties is not shared. The implementation of EIP-2981 standard ensures that information concerning royalties payment is shared and a single address where same is to be remitted is known.

In addition to this, the implementation of the EIP-2981 standard guarantees royalty payment across all marketplaces, both on-chain and off-chain. With the existence of an on-chain royalty payment percentage calculation function within the standard, creators are ensured of getting all accruing royalties on all secondary sales across on-chain and off-chain marketplaces. This ensures universal royalty payment.

Use Cases for EIP-2981

With the implementation of the EIP-2981 standard, a fixed percentage of royalties on secondary sales of NFTs is payable to the creators of the NFTs. It will allow for the specification of the amount to be paid as royalties to the creator of an NFT after each secondary sale and same is paid on all on-chain and off-chain transactions in relation of the NFT.

Finally, it the adoption of EIP-2981 can allow artistes to implement a model for a flexible royalty structure that is subject to change based on frequency of secondary sales and sale amount. With a standardized model for royalty payment, creators can for example upgrade royalties payable depending on frequency of secondary sales and sale amount. They can also choose to not receive royalties if artwork is sold for less than a specified amount.

Introduction

Over the years, the existence of intermediaries such as corporations and centralized platforms that possess a monopoly on creative ownership has hindered artists from enjoying the full economic value their artworks have to offer. However, with the advent of Non-Fungible Tokens(NFTs), the creative business has been drastically transformed and a new paradigm that allows for direct creative ownership between artists and their communities, free of centralized organizations, has emerged. With this phenomenon, an artist is able to mint their work, turn in to a digital collector’s item allowing such artworks to gain value.

The NFTs Marketplace

The one-stop destination for creating, listing, sale and purchase of various forms of valuable digital arts and crypto collectibles as NFTs are commonly referred to as NFTs Marketplaces. They are decentralized platforms that allow users to create, buy, sell and store non-fungible tokens.

Generally, these specialized marketplaces for the listing and trading of NFTs possess certain features. There is usually a dashboard that provides users with all the information needed for a listed asset such as the owners of such asset, the bids on the asset, the value history and also offers previews of the digital collectible. More advanced marketplaces also have a function for advanced token search that allows users to get complete information on listed NFTs via a simple search. Further to this, NFTs marketplaces allow users to place bids for and buy NFTs recorded on the platform. Users are also allowed to create, list, and send digital assets and crypto collectibles on NFTs Marketplaces.

Streamlined and Augmented Market Places

Broadly speaking, NFTs marketplaces can be categorized into Streamlined Market Places and Augmented Market Places. An NFTs marketplace is streamlined if it offers a broader range of digital collectibles as NFTs and provides sellers with fewer and more generic services. This kind of marketplaces are mostly concerned with facilitating efficient transactions through the provision of for example a payment infrastructure to enable the sale and purchase of NFTs. They also enjoy a broader base of users because they offer a more diverse collection of NFTs for sale.

On the other hand, an augmented marketplace is a niche marketplace that focuses and services a narrower category of users. Unlike Streamlined Market Places, Augmented Market Places offer a numerous value added services including but not limited to minting of NFTs, marketing, curation, price recommendations, portfolio trackers and so on.

The Plague of Centralization

NFTs, like the bulk of crypto assets, are built on decentralized blockchain technologies. This implies that they are not controlled by any central authority, thereby empowering individuals to own and control the dissemination and monetization of their work. The promise of decentralization upon which these NFTs marketplaces claim to be built is however not guaranteed as many NFT platforms are more centralized than users are made aware of.

A centralized platform is one in which a central authority is in control of its data and functions. For example, because social media platforms are built on centralized systems, they exercise total control over the use of most aspects of the platforms like who can and cannot join the platform, what can and cannot be posted, who controls and handles data of users.

There is no gainsaying in denying the fact that the preference for NFTs market places to be powered by centralized platforms is as a result of their high performance and ease to implementation. These market places are also assured of data integrity since the entirety of the database is stored at a single location. This ensures that data is managed in the most consistent and accurate way. Further, NFTs marketplaces know that since data is stored on a single centralized platform, data redundancy can be controlled since data is not stored or distributed on other platforms. It is therefore easier to ensure that the data stored are not duplicated thus, controlling redundancy. It is trite that decentralized systems are expensive to build as they require more computational resources and are more complex to implement. Most NFTs marketplaces prefer to be powered by centralized platforms as they are easily accessible, cheaper to maintain and easier to implement.

However, reliance on centralized systems or web 2 based platforms to power market places for the sale of NFTs poses major risks. A significant risk that is posed here is loss of data. When an NFT is purchased, the token that represents the ownership of the art itself is stored on the blockchain for everyone to see. However, since on-chain storage of large files is costly, NFT platforms that rely on centralized storage servers store the art, metadata, or media that the token correlates to off-chain on these centralized platforms. This put the NFT at the risk of being lost forever if the centralized platform stops operating.

Speaking on the location of the media referenced by NFTs, Jonty Wareing, in a twitter thread noted that the token that represents the NFT which lives on the blockchain references a media which itself is off-chain as an HTTP URL metadata file or an IPFS hash.

https://twitter.com/jonty/status/1372163423446917122

https://twitter.com/jonty/status/1372165292751732740?s=20&t=5r-4j4EJ8U4B9gkE_2wyiQ

Jonty, in his thread referenced the record breaking sale of Beeple. The token references a metadata that is accessible through a public IPFS gateway. The image however is stored through MakersPlace’s private gateway. In a situation where by Makersplace were to stop operating, the collector of B***eeple’s “Everydays: The First 5000 Days***” for 69 million dollars would be left with an image that can no longer be accessed.

Another risk associated with reliance on centralized platforms to power NFTs marketplaces is the issue of censorship and data tampering. Centralized platforms often censor accounts that post anything that goes against their terms of service and objectives. The risk of data tampering is also heightened when data is stored on centralized platforms. Centralized platforms, often operate a singular server upon which all data are stored. This makes them much more susceptible to hacking and system failure. In March 2021, the popular NFTs Marketplace, Nifty Gateway experienced the first digital NFT theft. A user on the platform claimed to have lost over $150,000 worth of their collectible tokens.

https://twitter.com/KeyboardMonkey3/status/1371347900748460034?s=20

In addressing this issue, the Company, via its twitter account stated as follows:

“We have seen no indication of compromise of the Nifty Gateway platform. The Nifty Gateway team is communicating with a small number of users who appear to have been impacted by an account takeover.

Our analysis is ongoing, but our initial assessment indicates that the impact was limited, none of the impacted accounts had 2FA enabled, and access was obtained via valid account credentials.

We encourage our users to enable 2FA that we provide on the platform and never reuse passwords. We have seen some reports that NFTs involved in these account takeovers were sold in transactions negotiated over Discord or Twitter.

We strongly encourage all Nifty Gateway customers to purchase their NFTs on the official Nifty Gateway marketplace.”

Similarly, on December 7th 2021, Amazon Web Services (AWS) experienced an outage in its key US-East-1 region and this outage affected a number of websites hosted on the platform, one of which is dYdX, a decentralized exchange platform. In its official report via its Twitter account, the platform acknowledged the fact that there were still some parts of the Exchange that relied on centralized services and that the downtime was as a result of AWS outage which have impaired its operations.

https://twitter.com/dYdX/status/1468293558360805381

https://twitter.com/dydxprotocol/status/1468293558360805381

Making a case for complete Decentralization of NFTs Marketplaces

Transactions are safe and less likely to be tampered with.

Building an NFT marketplace that rely on a fully on-chain decentralized platform guarantees safe and secure interaction with users of the marketplace. Transactions are more secure and less likely to be manipulated. NFTs marketplaces, can increase transaction security and build trust and confidence in their customers by avoiding the brokering of user data through dependence on web 2 centralized platforms and maintaining a fully decentralized infrastructure.

NFT Portability

Complete decentralization of NFT marketplaces provides an avenue through which creators and collectors of NFTs alike are able to mint and move their NFTs from one marketplace to another. When an NFT marketplace has been designed to live entirely on-chain, as opposed to what obtains now, the storage of both metadata and media is completely decentralized and as such continual existence of the NFTs is guaranteed.

Artistes and collectors are in full control of transactions

Artistes looking to sell and collectors looking to buy NFTs are in total control of their various transactions. Users have the liberty to initiate transactions without any form of approval from a centralized authority. The process of verifying transactions is free of third party interference as cryptography ensures that the data is properly validated and secure.

Conclusion

In marketplaces for art, reliance on centralized authorities is a phenomenon that is as old as time itself. More often than not, these platforms and not creators of the art themselves monetize and enjoy most of the pecuniary value created from primary and secondary sales of these works of art. The advent of decentralized data networks and applications has however made it so that centralized authorities no longer hold the power to act as intermediaries between creators and collectors of art thereby stripping them of their exploitative powers. Transactions can now be handled on fully decentralized platforms where creators and collector are able to determine the terms of their relationships and creators get to enjoy all the economic value generated by their works. It is true that building a fully decentralized marketplace where creators and collectors can transact free of third-party authorizations have been undesirable for a number of reasons. However, as the web3 technology continues to unravel, an understanding of better ways to improve security of transactions and creating new models for ownership continue to present themselves. The vulnerabilities associated with centralized systems are also being highlighted, as is an awareness of how they might be mitigated by decentralization.

Reference

1. “Non Fungible Token Definition”: https://www.investopedia.com/non-fungible-tokens-nft-5115211

2. “Step-By-Step Guide On How To Develop An NFT Marketplace Platform”: How to develop NFT Marketplace Platform| NFT Marketplace Development (leewayhertz.com)

3. “Web 2 vs Web 3” https://ethereum.org/en/developers/docs/web2-vs-web3/

4. “Making Sense of the NFT Marketplace” : https://hbr.org

5. “Centralized Database Systems, Characteristics, Advantages and Disadvantages”: https://t4tutorials.com/centralized-database-systems-characteristics-advantages-and-disadvantages/

6. “Lessons From the Nifty Gateway NFT Heist: Not Your Keys, Not Your Art” : https://www.coindesk.com/tech/2021/03/17/lessons-from-the-nifty-gateway-nft-heist-not-your-keys-not-your-art/

7. “The Pitfalls of Centralized NFT Platforms”: https://blog.portion.io/the-pitfalls-of-centralized-nft-platforms/

8. “Image 1”: https://twitter.com/crypto_thai/with_replies

9. “Image 2”: https://essential-addons.com/elementor/create-your-own-nft-marketplace/