NVIDIA (NVDA 1.69%) recently announced a trendy new product: a cryptocurrency mining processor (CMP). These chips are specifically designed for mining Ethereum (ETH 0.09%), and the first shipments are expected to launch later this month.

This move has several big implications for NVIDIA's business. Here's what investors should know.

What does it mean to mine Ethereum?

Every time someone sends or receives an Ethereum token, a transaction occurs. And these transactions are processed in batches known as blocks. For example, if I buy an Ethereum token right now, that transaction will be grouped alongside other transactions until a block is formed, at which point that block can be mined. Specifically, miners use powerful computers to discover the cryptographic hash (i.e. solve the math problem) that validates the block.

Digital currency concept art.

Image source: Getty Images.

Once the block is validated, it is added to the chain of all previous blocks in the Ethereum network -- that's where the term blockchain originates. While blockchain technology has applications outside of cryptocurrency, it was first invented by the unknown creator of Bitcoin (BTC -0.20%). And since a cryptocurrency's blockchain contains a record of all past transactions, it is the equivalent of a distributed ledger.

In other words, blockchain technology eliminates the need for a central banking authority. Miners unlock additional Ethereum during the processing of the block (it sort of serves as compensation for their computational efforts), which means no bank needs to issue the currency. Likewise, after solving the block's cryptographic hash, all other computers on the Ethereum network must verify the solution. If approved, the block is added to the blockchain, making all transactions part of the permanent record. In other words, there is no need for a central bank to act as a record keeper.

How does NVIDIA benefit?

In order to mine Ethereum, miners require powerful hardware. Not surprisingly, NVIDIA's graphics processing units (GPUs) -- which are best-in-class solutions for compute-intense tasks like data analytics and artificial intelligence -- are also very good at mining cryptocurrency.

NVIDIA's new cryptocurrency mining processor is specifically designed for the Ethereum network. Despite being the second-largest cryptocurrency, the value of an Ethereum token has surged over 1,660% in the past year, outpacing Bitcoin's 1,171% gains. Moreover, mining Ethereum is much more profitable than mining Bitcoin since there are more tokens available to be mined, which means there should be plenty of demand for NVIDIA's new product.

The other benefits

When NVIDIA announced the CMP, it also indicated that its latest gaming graphics cards -- the GeForce RTX 3060 -- are capable of identifying the Ethereum mining algorithm. To ensure that gaming GPUs end up in the hands of gamers (not crypto miners), the RTX 3060 is configured to limit computing power when used to mine Ethereum.

This will act as a deterrent to crypto miners, and it should help the company resolve the current shortage of gaming GPUs. But there is still another benefit.

Investors may remember NVIDIA's dismal financial performance in fiscal 2019. As demand from cryptocurrency miners evaporated, excess channel inventory resulted in reduced GPU shipments, which led to a 24% drop in revenue in Q4 2019.

At the time, CFO Colette Kress said: "Crypto mining demand and its after-effects have distorted the quarter-to-quarter trends in the gaming business and obscured its underlying trend." In other words, NVIDIA misjudged the portion of demand coming from the crypto community, and the company was caught flat-footed when that demand was greatly reduced when the price of Bitcoin fell significantly.

That's the other benefit of NVIDIA's new CMP. By launching a processor dedicated to cryptocurrency mining, while simultaneously hampering miners from using gaming GPUs, NVIDIA will be able to better quantify the portion of demand coming from the crypto community. This should help the company better manage demand and avoid a repeat of the inventory snafus from a few years back.