Issue #62: Music NFTs

This issue was inspired by conversations with @BlockchainBrett, investor at Palm Tree Crew Crypto, a venture fund focused on the creator economy.

A high school knee injury led me to music. I was on crutches for a year and a half and forced to find a new hobby that didn’t involve impact on my lower body.

For whatever reason, I decided on making beats (hip hop instrumentals). It wasn’t totally out of left field. I played piano as a kid and was always intrigued by the technology aspect of recording music. I bought a keyboard (Korg Triton workstation), a Pro Tools MBox and a few online drum kits and started making music. I was hooked.

When it came time to apply for colleges, I wanted to study music business. The dream was to be a producer. Maybe a manager. I spent the majority of college working for an independent rap label. Post college and during law school, I had short stints at music management companies and entertainment law firms.

By the end of law school though, my professional interests shifted and I dove head first into tech. Not long after, I was introduced to crypto and the rest is history, but I always knew my experience in music would come full circle and here we are.

Music NFTs are everywhere. You can’t scroll through Twitter without seeing half a dozen references to the impact they have on the artist’s ability to monetize their work and reimagine the relationship with fans. I’ve even started buying them.

What I couldn’t articulate though was how and why. NFTs are a vehicle for digital scarcity. The overlap with visual art is intuitive, but how exactly does that translate to a new business and engagement model for musicians?

That’s the topic for today.

Let’s zoom in…

State of the Music Industry

A little context. The music industry is like the tech industry in many ways - fueled by investors who pump cash into projects until they are anointed the “winners”.

At the center of the industry are record labels. They are like venture capitalists with a marketing budget. Like a tech VC, they inject cash into dozens of new artists every year in the form of recording, marketing, radio and touring costs, etc. in the hopes of creating the next unicorn that nets 100x their investment.

Their money isn’t free. Artists typically give up their “master copyrights” in the sound recordings (aka equity) in exchange for financial and promotional support. The difference between an artist and a startup is the artist has one investor (the label) that they rely on for everthing, whereas a startup has a cap table full of investors. All their eggs aren’t in one basket.

It’s definitely a tradeoff, and there are hundreds of cautionary tales about artists trapped in bad deals with labels that don’t support them.

Mo’ money. Music sales peaked in the 90s, then suffered from a decade long decline brought on by the Internet and digital formats. Thanks to streaming, recorded music revenues are back up to pre-Napster levels and expected to continue rising over the next decade. Goldman Sachs estimated recorded music sales (streaming, digital and physical sales) of $23.5B in 2021, and will likely reach $50B by 2030. Labels are flush with cash and aggressively investing in new acts.

Mo’ consumers. Spotify and Apple Music have further commoditized the music product into a one-size fits all subscription model. As a result, consumption has exploded. It’s expected that 1.2 billion people will be a streaming customers by 2030. Streaming is growing faster in places where pirated music was more prevalent over the last 20 years (Southeast Asia, Africa, Latin America).

Mo’ music. 35,516 albums were released in 2000. By 2010, the number was 100,000. In 2021, there were 60,000 tracks uploaded to to Spotify each day. More music is being created now than ever before thanks to affordable home recording equipment and distribution platforms like Tunecore.

Shoutout to Reid Martin, my close friend and music manager who provided this succinct summary of the 2022 music industry during a 30 minute phone call while he was walking through the streets of NY.

Music NFTs

Before we explore music NFTs, I want to revisit the original category of NFTs…art.

Let’s take a physical painting as an example. A single painting yields three categories of assets:

• Intellectual property rights to the image, and the ability to commercialize

• The original painting, and associated property rights (ability to resell)

• Prints of the original painting, and associated property rights (ability to resell)

Due to the physical nature of an original painting, it is inherently scarce and benefits from supply and demand market dynamics. A 1/1 work demands a higher price than a 1/1000. It looks the same as the prints, but there is social value that comes with owning something that noone else has.

Now let’s take a digital painting. A digital painting only yields two categories of assets:

• Intellectual property rights to the image, and the ability to commercialize

• The image file, which can be replicated an infinite number of times

For a digital painting, there is no concept of an “original”, and no native way to ensure scarcity…until NFTs.

NFTs fill the scarcity gap left by the inability to have an original piece of digital art. And the artist has control over the supply. NFT art is 1/x, where x is determined by the creator.

Now let’s tackle Music NFTs…

A piece of recorded music (aka a song) yields three categories of assets:

• Intellectual property rights associated with the sound recording (“masters”) and the musical composition (“publishing”)

• Product (CD, vinyl), and associated property rights

• Live performance

Everything else (streaming, digital downloads) derives from the above.

Now unlike art, music isn’t intended to be scarce. It’s intended to be consumed. Music is sold in units at a fixed price per unit ($9.99 for an album, $0.99 for a download), implying supply and demand equilibrium. There will always be enough supply to meet demand.

Scarcity only enters the picture in two scenarios - (1) if the master copyrights are being sold. This is the equivalent of selling the IP and the original painting combined; and (2) the live performance. Unlike the sound recording, the physical performance of a song is scarce. That’s when you see supply and demand dynamics take over. Tickets to a hot show sell for more than face value.

At a basic level, NFTs give a music artist a mechanism for layering scarcity on top of an abundant product. It combines the features of an original painting with the digital format of today’s music. This brings supply and demand market dynamics into the picture.

Here’s a snapshot of the Music NFT market today…

• Dominated by small, independent artists. NFTs are still niche, major label artists have more red tape. Artists with major label deals have exclusivity clauses in their contracts, so any recorded music they release is subject to the terms of their record deal.

• Demand outweighs supply. Every drop on Sound.xyz and Royal.io sells out immediately, regardless of the artist. Not surprisingly, roughly 25% of the NFTs sold are listed for sale on secondary markets within 24 hours. There’s still a healthy amount of speculation in the market.

• Simple use cases. Most of the music NFTs today are collectors items capitalizing on the speculative fervor in the market. You get a scarce token that points to an offchain audio file. It’s like a limited edition digital download you can resell.

That’s where it starts. We’re already seeing the next generation of music NFTs that have royalties attached, allowing the owner to enjoy in the upside from the song’s success. The challenge with these is the commercial infrastructure supporting the music industry today is entirely offchain. The terms of record and publishing deals live and are enforced offchain. Music consumption is offchain. Royalty accounting and payments are offchain. If an NFT needs to interact with any of these components, a third party needs to sit in the middle and facilitate the interaction. That introduces complexity, cost and time.

It’s the same uphill battle real world assets face coming into DeFi.

Where we go from here

I’m most excited about music creation and distribution models that are Web 3 native. @gah650’s Song That Owns Itself project is a peak into the future of autonomous and DAO-controlled IP.

Last week’s topic of open source IP issued under the CC0 license is another trend that musicians will start experimenting with too. Can a piece of music stop being the product, and be the platform instead?

I think it can.

Thanks for reading,

Andy

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