Graphics specialist NVIDIA (NASDAQ:NVDA) has been a beneficiary of the surge in the prices of cryptocurrencies. Many cryptocurrencies are produced through a process known as "mining" and NVIDIA's graphics processors, which are designed to handle the calculations required to quickly render 3D graphics, happen to be quite good at mining.
The suitability of NVIDIA's graphics processors for the mining of certain popular cryptocurrencies like Ethererum and ZCash has made them popular among cryptocurrency miners, and as the prices of those cryptocurrencies soared, so too did demand for NVIDIA's graphics processors.
Unfortunately for gamers, miners -- the primary buyers of NVIDIA's graphics processors -- had been scooping up NVIDIA graphics processors for months to mine cryptocurrencies. This, at best, made it so that the street prices of NVIDIA's graphics processors were highly inflated compared to the suggested retail prices of those cards, and at worst, it made it so that gamers simply couldn't find graphics cards to buy.
On the surface, it may seem as though NVIDIA shouldn't care whether it sells a graphics card to a cryptocurrency miner or a gamer, but over the long term, sales to gamers are far more important than sales to miners.
Fortunately, as cryptocurrency prices have come down and as dedicated cryptocurrency mining chip companies roll out chips that can mine Ethereum and other similar cryptocurrencies far more efficiently than NVIDIA's graphics processors could, graphics card supply has improved and street prices have come down.
Here's why that's good news for NVIDIA's core gaming graphics processor business.
Gaming demand is sustainable, mining isn't
There are two major forces that have driven the impressive growth in NVIDIA's gaming graphics processor business, which has enjoyed a 29% compounded annual revenue growth rate over the last five years.
The first is that NVIDIA's selling progressively more expensive graphics processors. This is due largely to the continued increases in the graphical fidelity of top games. People want to run games at higher-quality settings and at higher display resolutions and both of those things require more graphics horsepower. NVIDIA's gaming graphics card business has enjoyed an 11% compounded annual growth rate in average selling prices over the last five years.
The second is that there are simply more people choosing to play games on personal computers. This leads to more sales of both pre-built computers that incorporate NVIDIA's graphics cards as well as sales of individual graphics cards to gamers via online and retail distribution channels. NVIDIA says that gaming graphics processor unit shipments have grown at a 15% compounded annual rate over the last five years -- outpacing even the average selling price growth story.
Gaming demand is fundamentally sustainable as long as people increasingly want to play personal computer games and as long as those games require increasingly powerful graphics processors to look their best.
Mining demand, on the other hand, is volatile and far from assured with numerous risks associated with it. For one thing, if a cryptocurrency becomes popular enough, chip companies will rush to build chips dedicated to mining those specific cryptocurrencies that are substantially more powerful than graphics processors and more power efficient, rendering graphics processors unattractive for mining. This is what happened with bitcoin and why it's generally not a good idea to mine bitcoin with graphics processors anymore.
Moreover, if a cryptocurrency that is currently produced through mining shifts to a model, known as proof of stake, that doesn't require the vast amount of computing power to verify transactions, demand for processors that are used to mine those cryptocurrencies will quickly fall off a cliff. Ethereum, the most popular cryptocurrency that's mined by graphics processors, is soon expected to move to a proof-of-stake model.
Finally, even if the other two risks don't play out, if the overall market for cryptocurrencies heavily influences the profitability of graphics processor-based mining operations. If the values of the popular cryptocurrencies that are mined with graphics processors drop substantially (Ethereum, for example, is now worth less than half of what it was at the beginning of the year), mining becomes less lucrative and demand for graphics processors drops.
It's not just about sustainability
The reality is that while graphics processor demand from gamers is more sustainable than demand for those products from cryptocurrency miners is, there's another factor to consider: the negative long-term impact that scarcity of gaming-oriented graphics processors will have on the personal computer gaming market.
If gamers are forced to pay inflated prices for gaming-oriented graphics processors or if they simply can't find any of those processors to buy, then there's a reasonable chance that they'll throw in the towel on gaming on the personal computer and buy either an Xbox or a PlayStation -- two game consoles that NVIDIA has no presence in.
Indeed, game console makers have been updating their consoles with new hardware at a more frequent pace than they had in the past, presumably with the goal of stopping people from migrating to personal computer gaming. In a scenario where game consoles are getting more and more powerful and graphics cards for personal computers are hard to acquire, personal computer gaming could become less popular.
That reduced popularity could create a negative feedback loop; as gamers defect to consoles, game publishers find it less financially compelling to build titles for personal computers, reducing the number of titles that make it to personal computers and hurting the viability of the platform.
A key strength of the personal computer for gaming is that hardware advances are so frequent and the cost for a given performance level continues to decline that the platform is increasingly attractive. Graphics processor demand from cryptocurrency miners threatens to damage that value proposition and, ultimately, hurt NVIDIA's core gaming graphics processor business -- a business that made up more than half of NVIDIA's revenue in its most recent fiscal year.