Shariah Principles of Royalties in NFTs

Introduction to Royalties

Royalties are payments to owners of property for use of that property. Royalties often deal with payments for the right to use intellectual property (IP), such as copyrights, patents, and trademarks. Royalties appear in many different industries, but they serve a similar purpose in all uses. These royalties are granted by agreement, and they allow others to use the property, giving the owner the benefit of an income from this use. Royalties also protect the buyer from claims by the owner for improper use. Some common forms of royalty payments include:

  • Royalties for specific products (like a book, a piece of audio, a patented product, or a concert) are generally based on the number of units sold.
  • Royalties for oil, gas, and mineral properties may be based on either revenue or on units, such as barrels of oil or tons of coal[1].

Intellectual Property and Intangibles in Shariah

Intellectual property and intangible rights are considered as rights (Huquq) in Shariah. In earlier times, such rights and intangibles were not permitted for trade. The Hanafi jurists did not permit the sale of all rights independently, as they were not something which could be transferred by sale to the counterparty, and therefore could not fall under the purview of a sale in Shariah, which required the exchange of two properties. And since rights could not be transferred and exclusively retained by the counterparty, the rights could not be stored independently and retrieved for use at will, this ultimately negated them from being valid property (Mal). As time passed and society developed, the use of rights and their subsequent trading initiated. People began to deem certain rights as transferrable goods. A social understanding and recognition among people of the existence of these rights and their utility increased. An understanding of rights as something intangible yet exchangeable and transferable was developed[2]. This phenomenon was witnessed, recorded and upheld by social convention (Urf) to such an extent that a person could claim and demand for such rights in the court of law and it would be upheld by the courts. Urf allowed the recognition of these rights as property, their reporting and settling in case of dispute. The ability to record these rights in an orderly fashion which was recognised by the people gave them the ability to be ‘stored’ and be ‘retrievable’. Hence, contemporary scholars like Mufti Muhammad Taqi Uthmani and others state that since many such rights are recorded and stored in legal registers, it gives these rights legal existence like that of legal persons. The existence in such registers gives it a permanent and fixed existence. The financial world acknowledges the existence and value of such intangibles. As such, it is permissible to trade and sell such intangibles[3]. The AAOIFI Shariah Standards also recognises the permissibility of intangible rights. The Shariah Standard No.42 on Financial Rights states:

“3/3/2 Types of rights to intangible assets: Rights to intangible assets are of many kinds, including rights to trade name, trading addresses, trademarks, commercial licenses; intellectual property, technical and industrial know-how, patents and copyrights.

 3/3/3 Rules governing rights to intangible assets:

 3/3/3/1 Rights to trade names, trading addresses, trademarks, copyrights, inventions and patents are the rights of their respective owners. These possess recognised monetary value in contemporary business and commercial custom. Since these rights are recognised and protected by the Shari’ah , it is not permissible to violate them.

 3/3/3/2 Since rights to intangible assets are recognised as financial rights, it is permissible to dispose of or transfer them for consideration provided that such transactions are free of Gharar (ambiguity), deception and fraud.”

Royalties in NFTs

In NFTs, royalties can be built into the code by way of smart contracts, a method of pushing a portion of the resale proceeds back to the original creator. The smart contract is a code that is executable upon the occurrence of an event that causes something else to happen, in this case, the transfer of proceeds or portion of the proceeds from the resale of the NFT on a particular marketplace[4]. The NFT royalties are automatic pay-outs to the author made on secondary sales. These are coded into the smart contract on the blockchain. Each time a secondary sale happens on a marketplace, the smart contract ensures that the terms of the NFT are fulfilled. If a royalty is specified, a cut of the profits goes to the artist who created them[5].  NFT royalty payments are typically perpetual and are executed by smart contracts automatically, ranging from 5-10% in most instances. Blockchain technology and smart contract work together to ensure that the author is identified and the royalty payments are made immediately after the transaction is over. This removes any chance of the artist or author being cheated out of their royalties.

To read more about NFTs from a Shariah perspective, read: Anatomy of NFTs from a Shariah Perspective

Shariah Compliance of Earning Royalties

In transactions of property, once a sale (Bay’) is executed, the seller loses all rights to the sale asset. The seller has no right to gain anything from secondary sales. Any such stipulation would be an unfair term and not Shariah compliant. The Shariah does not permit a counterparty to have an advantage and unjustly enrich themselves from the other party. The reason for not being entitled to anything from secondary sales is that a person loses all connection with the sale item once a sale is executed. A seller has no further input or connection with the sale item, he has no rights attached, bears no risk, and therefore cannot benefit in any other way.

However, with the development of Intellectual Property and rights such as trade names, trading addresses, trademarks, licences, patents and copyrights, it is possible for the seller to have an ongoing attachment with the sale item. This attachment is recognised in legal, regulatory and accounting frameworks. These rights remain attached even when the sale item is sold and transferred to others. Since the owner of these rights has rights attached to the sale item no matter where the sale item is and who it is owned by, the seller still has a connection to the sale item. It is that connection which opens the door for the seller to gain from transactions.

Considering the above, the sale price of the item will be in lieu of the item, and the royalty charged will be in lieu of the intellectual property rights.

For the royalty to be lawful and Shariah compliant, the royalty earner must have some level of ownership rights, whether that is copyright or trademarks recorded in a licence agreement. Having no rights attached to the underlying asset and simply having a ‘royalty interest’ which gives right to collect a stream of future royalty payments is not Shariah compliant. That is tantamount to Rishwa (unlawful gains). That is because a person who has no connection with the sale item cannot benefit monetarily without bearing any interest or rights with the sale item.

Thus, for the Shariah compliance of royalties in NFTs, the person who minted the NFT must maintain copyright or other proprietary rights which will allow them to earn royalties coded into the smart contract. It is not Shariah compliant to earn a stream of royalties when the author of the underlying asset no longer owns any rights or interests in the underlying asset. 

A Word of Caution

Shariah does not recognise assets which are of no benefit to people in this world nor the Hereafter. Shariah requires that people only spend, invest, buy those things which bring about a reasonable and sought-after benefit. A price tag does not always correlate with value in the eyes of Shariah. Hence, it is of utmost importance that only those NFTs which bring about real and genuine utility in this world or for the Hereafter are minted, traded and invested in. If something does not fit into this worldview, it is junk and simply a waste of money. To read more on this, read: NFTs: Shariah Compliant?

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[1] https://www.thebalancesmb.com/what-are-royalties-how-they-work-4142673

[2] (المادَّةُ ٢١٦) يَصِحُّ بَيْعُ حَقِّ المُرُورِ وحَقِّ الشُّرْبِ والمَسِيلِ تَبَعًا لِلْأرْضِ والماءِ تَبَعًا لِقَنَواتِهِ. (مجلة الأحكام)

تَوْضِيحُ القُيُودِ – قِيلَ فِي المادَّةِ (تَبَعًا لِلْأرْضِ) لِأنَّهُ إذا بِيعَ حَقُّ المُرُورِ مُسْتَقِلًّا فالبَيْعُ غَيْرُ جائِزٍ عَلى رِوايَةٍ؛ لِأنَّ هَذِهِ الحُقُوقَ هِيَ مِن الحُقُوقِ المُجَرَّدَةِ ولِذَلِكَعِبارَةُ (تَبَعًا لِلْأرْضِ) قَيْدٌ احْتِرازِيٌّ عَلى هَذِهِ الرِّوايَةِ وعَلى رِوايَةٍ أُخْرى بَيْعُ حَقِّ المُرُورِ مُسْتَقِلًّا جائِزٌ وهَذِهِ الرِّوايَةُ أحْرَزَتْ قَبُولَ عامَّةِ المَشايِخ  (درر الحكام شرح مجلة الأحكام)

[3] Mufti Taqi Uthmani (2015). Fiqh al-Buyu’. Karachi: Maktabah Ma’ariful Qur’an

[4] https://www.talksonlaw.com/briefs/how-do-nft-royalties-work

[5] https://cyberscrilla.com/nft-royalties-what-are-they-and-how-do-they-work/