Secondary Royalties in NFT: Inefficient, anti-market & ethically suspect

It's time to talk about NFT secondary royalties, a poorly thought out monetization model that's inadvertently become a standard in the NFT art world despite its misaligned incentives, lack of decentralized enforcement and ethical ambiguity. The goals are sincere, to help artists capture high aftermarket valuations, but ignore the more optimal alternative of artist's reserve, attempting to solve a perceived IRL art world "unfairness" that doesn't actually exist.

The Problems of Secondary Royalties

Secondary royalties were introduced because it seemed a sensible way to capture the value in the speculative after market, with the basic idea being: "it's unfair if an artist's work sells for a very high value down the road when his sale price was much less, and they deserve an interest on those high value sales." However, a tax on every sale of the NFT into perpetuity introduces a lot of unnecessary complications that damage the health of the market, when more elegant alternatives already exist.

Liquidity Friction

The most obvious problem with the secondary royalty is it's a tax that creates unnecessary friction on the work's liquidity, since the tax event happens only whenever a sale is made. For better or worse, this compels collector's to hold when they may otherwise would not have - an inorganic intervention on the work's aftermarket movement.

Misaligned Incentives

The goal is to compensate the artist for increased valuation of their works, which is a goal aligned with their collectors; however the secondary royalty model only pays them through a tax on sales. This creates a conflict where artists are encouraged to design & distribute works that maximize trading liquidity, rather than simply high valuation. This is a subtle influence, but still introduces friction between the interests of the collectors and the artists, which ultimately negatively affects their art production and aftermarket.

Centralized Enforcement

Most people don't realize there is currently no ability to enforce NFT royalties at a blockchain level, it's instead applied by centralized secondary marketplaces (e.g. OpenSea) who've elected to arbitrarily give the ability to control platform royalties to the contract originator. It can easily be circumvented by avoiding these centralized platforms (See my discussion on "On Secondary").

The lack of genuine Web3 decentralization underpinning royalties leads to issues like the artist having freedom to change platform royalties post-hoc on sold works, with no recourse by their owners on the changed terms of sale.

It's worth noting as well that the major platforms like OpenSea obfuscate the royalties applied to each collection in their UX (on OpenSea, it's only visible when you attempt to make a sale).

The centralized platform royalties for artists also have made it an easy leap for the platforms themselves to justify taking cuts that they don't actually need to operate.

The current reliance on centralized (and closed-source) infrastructure has prevented the development of possibly more fair innovations on royalties such as a royalty decay over time (while occasionally suggested, a decay defeats the purpose of rewarding artist's for future reevaluations) or profit redistribution (if it's unfair for the artist to not realize the profits from high valuations sometime down the road, it would arguably be unfair to the original investors in the artist: the ones who supported it earliest when it was highest risk, but sold early. Shouldn't we also feel morally compelled to let them see some return in the future overvaluation for taking a large risk to invest into the unproven work and driving its initial growth?). There are few fairer alternatives for users to exit to.

Ethical Ambiguity

Whether or not secondary royalties enforced on a decentralized blockchain are technically even possible is debatable, because the concept fundamentally violates basic tenets of token ownership, leading to the final point: secondary royalties themselves poses an ethical question over NFT ownership.

An NFT fundamentally represents a deed of ownership, property owned exclusively and immutably by its wallet holder. Not only do secondary royalties violate this principle on a blockchain level, which is why it's debatable if they are even technically possible to decentralize, it creates a serious ethical question of whether an artist or gallery has any right to enact a perpetual tax on the use of your own property.

As far as I can think of, this kind of violation of your right to ownership is not a model that exists anywhere except in convoluted, IP-court reliant and generally consumer-exploitative contractual schemes. It strongly puts into question the claims that artist royalties should be respected despite their centralization for ethical reasons.

Artist's Reserve is the correct model for NFT Art World

Secondary royalties stem from a fundamental misunderstanding of the way value is actually generated in the art world: speculative investment into artists/groups/collections as a brand as a whole.

When they have a very highly valued sale, then all their other works increase in speculative value, including their earliest works, it's the nature of the art market. Even that sale's price point is partly informed by it driving the value of all the other artist's works in the market up.

The simple solution, and the standard in the IRL art world? An artist/agent's reserve.

It's simple, you mint but withhold from selling a few pieces from each collection, or series, or period of work. They do this both to avoid dilution on the artist's work in the market, and to see value as the artist's brand grows in valuation. As the brand grows, you simply reintroduce those works for sale to realize their new value.

In NFT's, this could look like a 5-10% artist reserve standard for any generative mint; or 1 out of 10-20 works for 1/1 artists. Owned by the artist and entirely up to their discretion to sell for funding alongside their primary sale royalties. An elegant and fair model - there was never a need to deviate.