Can Web3 Really Revolutionize Music Royalties?
Let’s weigh the pros and cons of NFTs for musical artists and their fans
Co-Authored with Bob Tarantino
A Tangled Web
Imagine you like a musical artist — actually, imagine you more than like them, you believe in them. You think their work has the potential to be huge. If only there was some way you could invest in their future. Now there is.
Two related forms of technology that have garnered significant attention over the last few years present opportunities for non-traditional participation in the recording industry. Blockchain technology coupled with NFTs introduce the possibility of enabling music business outsiders to share in the revenues generated by popular songs. We’re now at the point where fans can make a statement of their enthusiasm not just by listening to an album or attending a concert, but becoming part owners of the income generated by their favorite artist.
There is a degree of irony that the esoteric community pushing blockchain technology, or Web3, into the mainstream may end up being the same stakeholders who unravel a music royalties system defined by its inherent complexity. How music royalties “work” is infamously opaque: there is a confusing welter of distinct rights and rights holders, made more complicated by byzantine contractual arrangements and a myriad of different platforms through which music is exploited globally. How people get paid from the use of music involves a complex network of entities and flows of funds — an institution that has historically been closed to those who are not already players in the industry.
At a high level of abstraction, it can be helpful to think of music publishing as a linked chain. At one end of the chain are the songwriters and other owners of underlying copyrights in musical compositions and the record labels and performers that own copyright in the actual sound recording (or “masters”). At the other end of the chain are the multitude of people who “use” those compositions and recordings. This can include anyone that listens to, sells or provides access to music, ranging from online platforms like YouTube, Netflix and Spotify, to radio and TV stations, all the way to traditional analogue products like printed sheet music. The music industry’s revenue system aims to get money from those at one end of the chain (the “users”) to those at the other end (the “owners”). In between those two ends of the chain are a variety of different entities, which include “collectives” (including performing rights organizations and mechanical rights organizations — sometimes called “societies”), and the “publishing” companies. These organizations obtain and administer rights, grant licenses, track use, collect revenues, and ultimately remit a share of those revenues as royalties to artists/owners. Music publishers, who obtain administration rights directly from artists, often acquire some or all of the copyright in the composition, and charge administration fees that usually start at 10% and can go up significantly from there. And, the foregoing description is a dramatic oversimplification.
Music Royalties in Web3
Simplifying the process of tracking, collecting and distributing song royalties is a significant reason why Web3 music publishing will have every opportunity to thrive — creators want to break down the complexity of the current system and keep a greater percentage of royalties. Deploying distributed ledger technology (i.e. a blockchain) can reduce the complexities associated with music royalty tracking and distribution. Crucially, fans can be included in this system as participants. Web3 therefore presents opportunities for artists to crowdsource capital from their fans that give all participants a stake in future successes.
In the past year or so, numerous Web3-based platforms have sprung up attempting to either solve, or provide an alternative to, the current music publishing machine. Some of these initiatives include tokenizing audio files, auctioning versions of whole albums as NFTs, and selling fractionalized royalty allocations of new songs. Royal is one of the projects that have received most of the attention lately in this space. Hip-hop artist Nas and his record label Mass Appeal Records have teamed up with Royal to sell NFTs relating to two previously released tracks.
Royal.io is making available Song Tokens, or ‘limited digital assets’ (Royal’s version of an NFT) that give fans an opportunity to purchase shares in 50% of the streaming royalties earned from Ultra Black, on Nas’ 2020 album King’s Disease, and Rare, a single from the 2021 follow-up album, King’s Disease II. Nas owns the masters of these tracks, which were released by his own label, Mass Appeal. Users have the option to purchase tokens that represent various tiers in the streaming royalties for these songs, ranging from 0.0143% to 2.14% and may include added perks, like merchandise and tickets. Both the Ultra Black and Rare drops sold out almost instantly on January 20 and initial buyers immediately began trading their tokens for profit on Opensea, an NFT market that made these ‘assets’ available for secondary sales.
The legal contract for Ultra Black tokens sets out in detail what is, and what is not, being purchased. At its core, purchasers are buying a claim, memorialized on the blockchain, to a percentage of the royalties paid in connection with the exploitation of the sound recording of the song “Ultra Black” by Nas on “digital service providers”. In the language of the legal contract itself: purchasers are buying “a controllable electronic record minted on a blockchain as a non-fungible token (NFT) linked to the Artist’s percentage of the Streaming Royalties”. It is worth noting that “digital service providers” is not a defined term in the agreement — the contract only provides that it has the meaning that is “commonly used in the music industry”.
So what is being sold is not copyright, nor music publishing rights in the underlying composition, nor any physical item such as the digital file or a disc containing the sound recording — rather, what is being sold is the right to share in certain royalties generated from the exploitation of the sound recording itself. In simple terms, whenever the track (i.e., sound recording) is played on a service such as Spotify, the platform is obliged to make payments to the owners of that sound recording (namely Mass Appeal Records, with which Nas is affiliated) — and Ultra Black NFT purchasers are buying the right to share in those particular royalties.
Token purchasers will be paid their share of royalties in the form of USD Coin (a digital stablecoin pegged to the US dollar) on the Polygon chain and distributed automatically via a smart contract to each user’s applicable crypto wallet.
The biggest question raised by the Royal contract for the Nas drop is how the royalties will be collected in the first place — in other words, if, for example, Spotify is making a payment of royalties, how does that payment get from Spotify to the holder of an Ultra Black ‘Song Token’? The contract does not specify this process, and the onus will be on Mass Appeal Records to collect and remit those royalties. So, by purchasing the Song Token, purchasers are relying on Mass Appeal to hold up its end of the bargain and actually flow through the royalties to token purchasers. In other words, Mass Appeal appears to be the centralized entity in the process, notwithstanding deployment of a decentralized digital ledger.
Advantages of Web3 music royalties
At first glance, the advantages of Web3 for artists seems obvious — automate licensing and obtain the most revenue for your music. However, if you peek behind the curtains, the real value is in customer access. As opposed to more nefarious data farming platforms, NFT buyers are well aware of the value that their data provides owners, and is actually a motivating factor for buying an NFT. Purchasing an NFT, whether it’s a music royalty allocation or a cartoon ape, provides users with an opportunity for exclusive access to additional projects, digital and physical goods and potentially, financial reward. Being a fan in the Web3 ecosystem is not like clicking a heart or pressing a ‘like’ button, it’s a mutually beneficial relationship between creator and admirer. NFT ownership is much more akin to membership in an exclusive club than a piece of art hanging on a wall.
Also, artists can now drop additional NFTs directly into the wallets of their users, whether for purposes of promotion, or to reward fandom, which creates a self-perpetuating network of fandom with no cost of acquisition. That is the thesis of the NFT community at its best: creators retaining control of their work while directly rewarding fans for their attention. Why give away publishing rights to an administrator when creators can give away publishing rights to actual fans, who will act as social evangelicals and reward the artist with enormous upfront capital and perpetual secondary market revenues?
The Web3 ecosystem will also provide new verticals to create and monetize music. A new generation of musicians have begun to write, record and perform works made specifically for the metaverse. Artists will always find ways to adapt to the medium of the day and immersive digital exploitation and consumption is an obvious future. It makes sense for artists to capture their audience with proof of fandom in NFTs and allow their community to expand and consume without outside influence. This creates a unique opportunity to construct a new music royalty paradigm that begins and ends on the blockchain with a fully-formed and functional tokenized royalty structure. A new contingent of fans await the artist to provide the soundtrack to their virtual lives.
“If the pre-internet/web1 era favored publishers, and the web2 era favored the platforms, the next generation of innovations — collectively known as web3 — is all about tilting the scales of power and ownership back toward creators and users.” — Li Jin and Katie Parrot, The Web3 Renaissance: A Golden Age for Content, 2021
Disadvantages of Web3 music royalties
There remains a significant number of challenges to be solved to get to a place of tokenized royalty administration. Perhaps the biggest hurdle is the interface between the existing royalty distribution system and current blockchain capabilities: in short, how can smart contract functionality ensure that royalty payments can get from a payor to the wallets of verified IP owners? Solving this is a function of putting in place the necessary payment mechanics, numerous NFT deployment methods and smart contract construction ensuring perfect accuracy from the initial transaction.
Relatedly, there needs to be a form of dynamic interoperability between existing accounting, reporting and tracking systems of the current music royalty system and the blockchain — this ensures that there is no black box royalty gap. There are currently Web3 products in development, some of which are already being deployed, with the purpose of feeding smart contracts with data from the outside world, creating the opportunity to build a blockchain-based project that can use real world validation from trusted data sources in real time.
Also, the globalized nature of the blockchain and NFT markets may raise significant securities law issues. Some platforms, such as Royal, take the position that what they are selling are not “securities” (and thus not subject to the jurisdiction of national securities regulators such as, the United States’ Securities and Exchange Commission (SEC)). Other platforms, like SongVest, are of the view that what they are selling are “securities’’, and they have taken steps to comply with SEC requirements. Given that purchasers can be located anywhere in the world, in theory, securities regulations from dozens, if not hundreds, of countries would need to be complied with.
Finally, as with many online transactions, enforcement issues are a perennial concern — NFT purchasers will face significant, and potentially insurmountable, hurdles to enforcing their contractual rights. Enforcing a contract is, at the best of times, an expensive, drawn-out process, often requiring legal expertise. That becomes a bigger hurdle if the parties to the contract are in different countries. Some contracts even preclude taking disputes to court at all: in the Ultra Black contract, for example, all disputes have to be settled by arbitration, and class action lawsuits are specifically precluded.
All of these potential barriers to implementation put a premium on trust and reliability: the best contract is one that is never breached and thus never needs to be enforced. While the immutable nature of the blockchain provides some security, there will inevitably be “leakage” because there isn’t yet a seamless integration between the non-blockchain financial system and the smart contracts contained on the blockchain. Also, how can consumers be ensured that the people who have the control of the revenue streams (artists and their representatives) actually move the royalties to the blockchain?
A future look
Most early Web3-based music royalty projects involve new songs, or songs created for the sole purpose of allocating royalties as NFTs. However, the real value for blockchain-based music royalties is in back catalogs and untangling the web of IP-rights holders from these assets may be an impossible feat. Nas, for example, already owns the masters to the two tracks he’s putting up on Royal, which significantly streamlines the process for tokenizing. As noted by Naithan Jones, head of growth for Royal, the company hasn’t ruled out working with artists who don’t own 100% of their music, but it’s easier to start with “the least encumbered IP”.
The last few years have seen an enormous boom in the sales of music publishing and other rights in the back catalogs of legacy artists such as Bob Dylan, David Bowie and Bruce Springsteen. However, the average fan is functionally locked out of those transactions, which have taken place between artists and well-capitalized incumbents like Universal Music and hedge fund-backed investment public companies such as Hipgnosis. These deals are founded on the fairly simple premise that popular music can reliably generate tens or hundreds of millions of dollars in revenue for decades. But those deals are, in a sense, backwards-looking and are aimed at artists whose catalogs were built decades ago, and reserved for those who are already tapped into the financial equity system. Music royalty NFTs are forward-looking and enable those with smaller amounts of deployable capital to make bets on the music of the future.
Various collectives, record labels and other stakeholders have already begun to modernize and converge with Web3 technology. In 2019, ConsenSys, a company building products and services for the Ethereum ecosystem, and the Harry Fox Agency, a US-based MRO, were chosen by the Mechanical Licensing Collective (MLC) to modernize music royalties data and capture previously lost or unclaimed royalties. As recently as last year, Società Italiana degli Autori ed Editori (SIAE), an Italian copyright collecting agency for authors and publishers, and Algorand, a blockchain platform, initiated a project that created over 4 million NFTs accounting for the rights of the more than 95,000 SIAE member authors. The SIAE/Algorand project, while not related to music royalties, could provide a roadmap for other music collectives of how to decentralize the metadata for an entire group of creators.
NFTs appear to capture the zeitgeist of an increasingly digitized culture. At first, art and sports collectibles piqued the interest of collectors and crypto-enthusiasts. Now, given the extent to which recorded music is already being digitally delivered, music-centric ventures are a natural transition to more utility-based projects in Web3. A number of blockchain startups, including Royal, Sound.xyz, and Opulous are betting on the music industry carrying the next big NFT wave. Skepticism from traditionalists is to be expected, but record labels saw their bargaining power diminish in the early 2000s when the internet broke their business model. Streaming has since saved most labels from total annihilation, but this has been at the cost of meaningful revenues reaching the pockets of a large number of artists. Web3 provides a beacon for creators and their fans to decentralize their economy, but technology and monetary structures need to catch-up to these aspirations. It will be interesting to witness this newly-formed tug-of-war between infrastructures and how our playlists will exist in the digitized landscape.