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Introduction to Music NFTs: Part One

Music is an industry rife with contradictions. The industry boasts the most followed people on earth, yet the vast majority of artists cannot make a sustainable living off of their craft. However, NFTs and other Web3 technologies are promising to change this unfortunate reality. Today, we dive into the history of the music industry, the promises of Web3, and how the current state of these technologies are impacting the music industry.

The Current Music Industry

To begin, let’s briefly go over a few of the entities that make up the industry value chain:

  • Songwriters / Composers who put together the melodic, harmonic and lyrical elements of a song;
  • Recording Artists, or the creators of a song;
  • Publishers, who hold the composition copyrights (the collection of notes, melodies, phrases, rhythms, lyrics, and/or harmonies);
  • Record Labels, who hold the copyrights of the sound recording (a particular expression of the underlying composition);
  • Distributors, whose primary responsibility is o get the music to where individuals are consuming music (earlier it was retail stores, today it’s on digital service providers);
  • Digital Service Providers (DSPs), i.e., platforms like Spotify, Apple Music, etc., where we listen to our favourite songs.

It is important to note that the aforementioned stakeholders (recording artists, publishers, labels, etc.) do not exist in silos and often perform several functions under one roof. With that context, let’s take a small detour through history.

Since the early 1900s, the medium of music consumption has been in a constant state of flux, from vinyl to radio, from cassettes to compact disks, from the Walkman to iTunes, and onto streaming services like Spotify and Apple Music today. In spite of this rapid evolution, the core structure of the music industry has remained unchanged.

The record labels (specifically the Big 3 of Universal Music Group, Sony Music, and Warner Music Group), have a near monopoly-like influence on the industry. This is because in the pre-digital era, they were the ones who discovered talent, financed production, and had strong ties with hardware manufacturers and the distribution channels (primarily retail stores).

Because of these legacy structures, these labels acquired a majority of the music rights, which has enabled them to continue their influence in the current digital era (despite the physical manufacture of vinyl, compact disks, etc., and distribution to retailers becoming a thing of the past).

Record Label Market Share 2020 (Source: Omdia, Music & Copyright)

Record Label Market Share 2020 (Source: Omdia, Music & Copyright)

As a result, these middlemen end up capturing the bulk of value that is generated by the industry. To put things into perspective, only ~12% of the value makes its way back into the pockets of artists. Historically, the rationale for this split made sense (to some degree). However, with physical manufacturing obsolete and digital distribution available to all, people are seriously questioning if the labels are providing value to the artist commensurate with the value they are capturing.

Music Industry Revenue (Source: Audius Whitepaper)

Music Industry Revenue (Source: Audius Whitepaper)

Now that we have a basic understanding of how the music industry works, let's briefly go over what the people involved with it identify as the main issues.

Industry Value < Cultural Value of Music

While the music industry is valued at ~$40 billion, it is dwarfed by the $300-400 billion gaming industry. While one can claim that this discrepancy is due to individuals valuing games ten times more than music, some indicators point to the contrary.

For example, the list of the world’s wealthiest musicians demonstrates a relatively consistent pattern – artists generate massive cultural recognition through their music, then go on to capitalise on it in entirely different industries. Just look at Dr. Dre and Beats/Apple, Kanye West and Yeezys/Adidas, Rihanna and Fenty, Diddy and Cîroc. On top of this, six of the top ten most followed individuals across social media are musicians, confirming the primacy of music in matters of cultural cachet.

Global Recorded Music Revenue from 1999 to 2018 (Source: MIDIA Research)

Global Recorded Music Revenue from 1999 to 2018 (Source: MIDIA Research)

Lastly, a look at the total industry size over time supports the claim that there are more fundamental/structural reasons that have restricted the music industry’s value, relative to other forms of entertainment. As you can see below, from 1999 to 2018, the revenue from music consumption in the USA has actually declined by ~25%!

Inadequate Creator Monetisation for the Long Tail of Artists

Source: Twitter.com/RAC

Source: Twitter.com/RAC

With an estimated ~12% take rate on revenue generated by their music, it is not surprising that the vast majority of artists are unable to sustain a living only from their craft. As such a miniscule amount accrues back to the artist, to achieve an income of ~$40,000, an artist would require upwards of 5 million streams. To state the obvious, achieving this consistently, release after release, is another ball game all together.

Too Many Middlemen

Due to the large number of variables required to bring a record into fruition, the legacy infrastructure upon which industry copyright law has been built, and the varying laws across geographies, it is no surprise that a plethora of middlemen have cropped up, all taking a slice (of varying proportions) of the pie along the way.

The Business Model of Record Labels

In a world where data was not as abundant as it is today, the record label business was a lot like the business model of venture capitalists. You deploy capital by betting on several teams, most of them go to zero, and a small minority of them return to provide asymmetric outcomes, making back your total fund corpus, and then some.

This was because it was one, very expensive to produce a record, and two, extremely difficult to predict which artist would do well prior to having a fully produced record released to the public. Effectively, labels had to pick which artists they wanted to invest in on very limited data points. This resulted in them capturing a large proportion of the artist’s future cash flow as compensation for their initial risk capital. In many instances, labels acquire ~80% of future revenues generated by all the artist’s work for a set duration, which only comes into effect after the initial investment is recouped by the label. Therein lies the problem.

Today, the cost of music production is at an all-time low, while the cost of music discovery is at an all-time high, arguably making marketing the most important tool of a record label’s toolkit. The critical question for artists to answer, then, is this: is it worth it to give up ~80% of future cash flows for predominantly marketing services?

Cost of Music Production Over Time

Cost of Music Production Over Time

Metadata Inconsistency

Metadata across the industry is not standardised, leading to several inefficiencies in key facets of the industry value chain. For example, with the rise of the DSPs identified above, each platform has its own proprietary search algorithm, thus requiring an artist to input a wide variety of metadata on each of these platforms. As you can imagine, in the hustle of meeting deadlines, things quickly go awry. The end result is a significantly suboptimal artist discovery experience and inefficient royalty distribution. The latter is worth emphasising because with metadata being inconsistent across geographies as well, it becomes very difficult to identify when exactly a legitimate royalty is earned, leading to lag times of months, in some cases years, for the royalty to finally make its way back to the artist’s bank account.

Technology Commoditizing Music

The unfortunate reality is that while the consumer experience of listening to music has never been better, it has come at the price of commoditising the art form. The unprecedented advancements in technology have fuelled the meteoric rise of passive music consumption, making the concept of meaningfully paying for music access foreign (like the $1 per track model of iTunes). While artists advocate for the open accessibility of music, their ability to generate revenues from only music consumption is rapidly declining. This is best exemplified, once again, by how the pay-out an artist gets for 1 million streams on any given DSP.

Misaligned Incentives

To conclude, we now live in a world where labels derive most of their revenue from artist streams, but artists derive most of their revenue from non-streaming sources (live performances, merchandise, etc.). This is primarily because of the way music copyright law is structured (which is well beyond the scope of this article). Nonetheless, this contradiction perfectly encapsulates why many stakeholders claim that the industry is broken and is badly in need of an evolution.

The Web3 Music Promise

Having covered the current drawbacks of the system, let’s go over how Web3 technologies can help offer a solution. While token-incentivised decentralised networks help in creating permissionless and censorship-resistant platforms for artists to publish their content, Non-Fungible Tokens (NFTs) have the potential to provide the greatest unlock for artists and their fans from a monetisation and engagement perspective.

Defining Music NFTs

As you’re aware, an NFT is simply a unique instance of any digital file. Similarly, think of Music NFTs as a subset that consists of all files related to the realm of music. It could be the album artwork, the album as a whole, an individual song, a melody, a bass line, and so on. Important to note is that just because you own, say, an NFT of a song, doesn't necessarily mean only you can consume the media. It can still exist on Spotify and Youtube for the whole world to access. Think of NFTs as a financial and engagement layer, on top of the existing experience of consuming music.

For perspective, before we get into the weeds, ~25 NFTs sold at 0.1 ETH is equal to revenue from ~1 million streams on a DSP like Spotify or Apple Music. Even though it is important to note that 0.1 ETH is no small amount, this example does show how small an audience one must reach or one’s art must resonate with compared to the current Web2 monetisation channels. From a fan and artist perspective, there are many benefits that music NFTs provide.

Social Status and Bragging Rights

As discussed in our own article ‘How to Analyse Profile Picture NFT Projects’, the verifiably scarce nature of NFTs makes them a very good ‘signalling’ tool. A music NFT can signal a variety of things – for example, being a purchaser in the genesis collection of a new mainstream artist can prove to your friends that you discovered the artist much earlier. This behaviour is unquestionably prominent amongst music aficionados – a game of pride – but never before has it been verifiable. In addition, if you purchase a high value NFT in the secondary market dropped by, say, Drake, it not only signals your fandom for the artist but also your financial clout.

Speculation and Financial Appreciation

For the first time ever, speculating on artists is not reserved to major music institutions. Retail can now capture a proportion of the upside if we discover an artist before they catch mainstream attention. Building on the first example, if you did buy the genesis NFT of an artist who has just gone mainstream, chances are the NFT is now worth a whole lot more than what you paid.

At a grassroots level, this possibility will catalyse the rise of a new class within the industry – scouters and curators, individuals who spend their energy on finding new talent and promoting it to an appropriate audience, with the hope that the music catches on and significantly increases in cultural, and consequently, monetary value. In essence, we can say that this is a new paradigm for artist discovery. With fans or speculators having a vested interest in the artist’s career, they act as on the ground missionaries, under the guise of organic growth.

Direct Fan-Artist Engagement

Due to the provenance of the blockchain, token-gated experiences act as new channels for fans to engage with artists. Of course, early access to content for NFT holders is an obvious use case, but offering actual 1-1 face time with the artist, behind the scenes access to concerts, collaborating on song production, etc., are other mediums of artist-fan engagement that are being actively being experimented with. Artists have never been able to tap into fan data to such a granular degree. Now that artists can verify the identities of their original fans from day one and effectively reach them, the design space to provide specific experiences is only limited to the artist's imagination.

Royalty Lead Time

On a similar note, as Web3 technology is built on top of the internet, royalties can now be attributed and distributed in real-time. From years to seconds – talk about several orders of magnitude improvement.

Novel Monetization Channel

NFTs, and Web3 technologies at a more macro level, are often perceived as the enemy of the current music industry in an ‘Us versus Them’ portrayal. The truth is that Web3 acts as a complementary set of tools to the current system. Specifically, it acts as a monetisation channel that offers the potential to actually make a sustainable living. Most importantly, this claim holds true for the long tail of artists as well. Due to the reduced size requirement for an ardent fan base, monetising via NFTs can be done by even the indiest of indie artists.

Interestingly, all this is possible without sacrificing the open nature of art, or in Web3 lexicon, composability. Now, artists can build on top of the work of other artists, without compromising value accrual back to the original artist. For example, if a song’s constituents (bass line, melody, etc.) are minted as individual NFTs, a second artist can simply use one of these NFTs in his/her new music NFT, and the on-chain royalties will always be triggered.

Lastly, these novel monetisation mechanisms provide artists full autonomy on how they should be implemented. Direct NFT sales, micropayments per stream, subscription-based access, selling future royalties (a concept David Bowie pioneered decades earlier) are just some of the options that are at the disposal of the artist.

Conclusion

And there you have it! You now know how the current music industry operates, and how Web3 holds the potential to revolutionize it. But the question remains - is this all in theory, or is this actually taking place in the real world? After all, a promise without execution is useless, to say the least. Thus, in the next piece in this 2 part series on Web3 music, we will cover what the current state of Web3 music looks like, and what it could look like in the short to intermediate term.

Stay tuned!

Published on Nov 03 2022

Written By:

Genesis Block

Genesis Block

@genesisblockpod
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