Chipmaker NVIDIA (NVDA -3.64%) is often mentioned in discussions of cryptocurrencies. Its high-end PC GPUs, which are usually used for gaming, also power cryptocurrency mining rigs.
During NVIDIA's recent dip from its historic highs, the bears claimed that tumbling crypto prices would throttle demand for its GPUs. In early April, Wells Fargo analyst David Wong declared that there are "multiple risks associated with Nvidia's exposure to cryptocurrency mining," which "could impact Nvidia's July 2018 and subsequent quarters."
However, Morgan Stanley's Joseph Moore recently fired back, stating that "in addition to longer-term data investment trends, we see shorter-term drivers in gaming offsetting crypto weakness, and progress in data center inference [machine learning] expanding the long-term opportunity."
I think Moore's argument makes sense, since NVIDIA's cryptocurrency business really isn't a core pillar of growth for the chipmaker. Investors should understand what miners actually use NVIDIA's cards for, how much revenue those cards generate, and the actual risks associated with the crypto market.
What do miners use NVIDIA cards for?
Miners generally don't use NVIDIA and AMD's (AMD -4.20%) cards to mine Bitcoin, the most well-known cryptocurrency. Instead, the cards are used to mine "alternative" cryptocurrencies like Ethereum, which are often more profitable than Bitcoin. Bitcoin miners generally use larger dedicated mining rigs powered by ASIC chips instead of GPUs.
NVIDIA's high-end cards are pricier than AMD's, but they're more powerful, require less power, and are easier to overclock. However, AMD's GPUs can process certain mining algorithms, like EThash for Ethereum and CryptoNight, more efficiently than comparably priced NVIDIA GPUs.
A single mining rig requires multiple high-end GPUs. Miners often place bulk orders for NVIDIA and AMD's video cards, which throttles the market supply and drives up prices.
That shortage frustrated gamers, who couldn't buy gaming GPUs at reasonable prices, as well as NVIDIA and AMD, which couldn't address the surging demand. To exacerbate that pain, big chip orders from Bitmain, the largest ASIC mining machine maker in the world, throttled the ability of TSMC -- the world's biggest foundry -- to produce new chips for NVIDIA and AMD.
How much revenue does NVIDIA make from miners?
Last November, NVIDIA revealed that it generated $70 million from crypto-related products during its third quarter, down from $150 million in the second quarter. NVIDIA CFO Colette Kress didn't disclose an exact dollar figure during the fourth quarter conference call, noting that "cryptocurrency trends will likely remain volatile," but stated that "strong demand in the cryptocurrency market exceeded our expectations."
Kress said that NVIDIA met some of the crypto market demand with a dedicated board from its OEM business instead of its gaming GPUs, which could reduce some pressure on the gaming market. Kress stated that the crypto business was "difficult to quantify," but that it generated "a higher percentage of revenue than the prior quarter."
NVIDIA's crypto revenues accounted for 7% and 3% of its second and third quarter revenues, respectively, so we can assume that percentage remains in the low single digits. Yet NVIDIA's total revenues rose 56% annually during the second quarter, 32% during the third quarter, and another 34% during the fourth quarter -- fueled by the strength of its gaming, professional visualization, and data center businesses.
What are the actual risks to NVIDIA?
The importance of cryptocurrency miners to NVIDIA's long-term health is overblown, but the crypto market still poses two main risks to the chipmaker.
First, an ongoing supply crunch could alienate PC gamers, who might buy cheaper consoles instead. That's why NVIDIA is asking vendors to restrict bulk orders, launching new dedicated crypto boards, and developing new GPUs which could split the mining and enterprise markets away from its core gaming market.
Second, stumbling crypto prices could cause miners to cut their losses and flood the market with used GPUs at low prices. This would be a boon to gamers, but NVIDIA and AMD could see their new GPUs cannibalized by old ones at dirt-cheap prices.
The key takeaways
Investors should remember that cryptocurrency miners only account for a small part of NVIDIA's overall business, and that the strength of its gaming, professional visualization, and data center businesses should offset the volatility of that market.
However, investors shouldn't ignore the crypto market's impact on the balance between supply and demand in the GPU market. If that delicate balance isn't maintained, we could see GPU prices either surge or plummet -- which could hurt NVIDIA's overall growth.