Nvidia ($NVDA) was the top performing stock in the S&P500 index in 2016, rallying a whopping 227%. 2015 and 2017 weren’t bad either, as the stock went up by 66% and 82%, respectively.
The story of Nvidia’s amazing rise, and subsequent fall, is a tale of wishful thinking, unintended consequences, and, of course, cryptocurrency mining.
1993: The origin story
Nvidia was founded in 1993 by three friends, who believed that general purpose computing, performed by a computer’s CPU (Central Processing Unit), would be incapable of keeping up in consumers’ demands in terms of graphics.
A year earlier, Wolfenstein 3D had established a new paradigm of what computer games should look like, and Doom, released in December 1993 shortly after Nvidia was incorporated, confirmed the trend. Consumers wanted real-time 3D games, and computer CPUs just weren’t designed for that purpose.
3D graphics use a very specific set of mathematical operations, which they call millions (and later on billions) of times every second. CPUs, with their central architecture, could only perform one operation per processor cycle. This makes sense for general purpose computing, where the code is executed in linear fashion, and the results of every step of execution are used in the next steps. But 3D computing was a whole different paradigm. It required a lot of matrix calculus, where hundreds of operations can be performed separately, before their results are added together.
This is the whole idea behind a GPU (Graphics Processing Unit): executing hundreds of calculations (“threads”, as they’re called in programming) simultaneously. A GPU chip is basically hundreds of smaller identical chips put together, each capable of performing the same set of operations independently.
The three founders – Jensen Huang (CEO as of 2019), Chris Malachowsky, and Curtis Priem, raised $20 million for their idea in a red-hot market for VC funding, and the adventure began.
2000s: General-purpose GPU computing
In the early 2000s, scientists and computer geeks realised that GPUs could be used for other purposes than just playing Lara Croft. GPUs, with their hundreds and thousands of calculus-oriented chips working in parallel, looked almost like something that could be used for many ressource-intensive tasks in their research, like mapping the human genome.
GPUs weren’t designed for executing anything else than 3D rendering. One had to literally hack their drivers in order to access their fabulous computing power, to a limited extent.
Quickly enough, GPU manufacturers noticed the interest from the scientific community, and started to adapt their technology for non-graphical use. Nvidia’s CUDA, released in 2007, was the company’s first product designed for non-graphic-use. As per Wikipedia:
CUDA is a parallel computing platform and application programming interface (API) model created by Nvidia. It allows software developers and software engineers to use a CUDA-enabled graphics processing unit (GPU) for general purpose processing — an approach termed GPGPU (General-Purpose computing on Graphics Processing Units).wikipedia.org
Starting from 2007, Nvidia invested quite some time and efforts into developing its general-purpose GPU computing. However, these efforts didn’t produce the expected results. Despite much fanfare, public relations and incentives, the world just wasn’t there yet. For ten long years, Nvidia continued its line of general-purpose GPU computing solutions, and had little to show for it.
Then, something happened in 2016. Nvidia’s management noticed a shift in demand for its general-purpose GPU computing solutions. They attributed this shift to a growing appetite for computational power from artificial intelligence. Self-driving cars in particular, needed a lot of GPU power to run regressions on all the data their captors and cameras were collecting, and Nvidia’s management believed that they could see the light at the end of the tunnel, at last.
This turnaround could be seen by the number of times Nvidia’s management mentioned GPU computing and artificial intelligence in the 10-K annual reports they file with the SEC, going back to 2008:
2014-2017: Nvidia’s big no-no of cryptocurrency mining
Despite Nvidia’s management’s conviction that a long-term bet was finally paying off, behind the scenes, something else was brewing.
On August 7, 2014, during Nvidia’s Q2 2015 Earnings Conference Call, an analyst from RBC Capital Markets mentioned the “C” word:
“If I could, one of the areas that I believe one of your competitors hit a speed bump on was the fact that GPUs were being used for cryptocurrency algorithms. Is this a market that you view as something that NVIDIA should be servicing, are you targeting your products at that and is it something that we should take into our thinking?”Doug Freedman, RBC Capital Markets
Jen-Hsun Huang, Nvidia’s CEO, tried to pull the discussion back to the official party line: Nvidia’s GPUs were great for what they were designed to do, i.e., gaming and artificial intelligence.
“First, the fact that you could run an arbitrary and newly developed cryptocurrency algorithm on a GPU says something about the programmability of a GPU now. That’s one of the things that – of course cryptology, cryptography is very important, of course encryption and decryption for security long-term will be very important, and GPUs will increasingly become important in the development of those algorithms.
However, we really didn’t benefit very much from people who were doing I guess bitcoin mining, and the reason for that is because if it’s just one application, if it’s somebody who is using that one application, they don’t really care about the gaming experience, they didn’t buy the platform for gaming, they didn’t buy the platform for workstations or design, I would say that NVIDIA GPUs are not the most performance per dollar efficient in the market.
I think in the final analysis I don’t think we were particularly the best choice for somebody who would like to bitcoin mine. When they were done, they resold the graphics cards in the marketplace, and I guess in a lot of ways I’m kind of happy that that didn’t happen to us.”Jen-Hsun Huang, Nvidia’s CEO
The remarquable thing about this answer is that Jen-Hsun Huang doesn’t say that Nvidia’s GPUs weren’t being used for cryptocurrency mining in general, only that they weren’t being used for Bitcoin mining, which is very different. In 2014, GPUs were no longer competitive in the Bitcoin mining business, as Bitmain had already issued its ASIC Antminers a year earlier in 2013, leaving GPU-based solutions in the dust. However, mining other cryptocurrencies was still very profitable with GPUs. Jen-Hsun Huang kinda, sorta denied that Nvidia’s GPUs were being used for crypto mining, without exactly saying that.
In order to understand the importance of this nuanced statement by the company’s CEO, look no further than the Sarbanes-Oxley Act:
“The Sarbanes-Oxley Act requires public companies to strengthen audit committees, perform internal controls tests, make directors and officers personally liable for accuracy of financial statements, and strengthen disclosure. The Sarbanes-Oxley Act also establishes stricter criminal penalties for securities fraud and changes how public accounting firms operate.”investopedia.com
This means that the company’s management has to disclose as much information about the company’s operations as is needed for investors to have a fair understanding of what’s going on. Clearly, Nvidia’s management didn’t want to draw attention to their products being used by crypto miners, but had to answer to Doug Freedman nonetheless.
Coincidence or not, Doug didn’t join in on the next two Nvidia’s quarterly earnings calls.
Following Doug Freedman’s oopsie, no analyst dared mentioning crypto to Nvidia’s management again for three full years.
During these three years, cryptocurrency miners were buying GPUs hand over fist, as can be seen by the thousands of tweets, forum posts, and Youtube videos asking and explaining how to use Nvidia’s products to mine Ethereum, Zcash, or any other cryptocurrency. Here’s a tutorial Published on 5 April, 2016, with over 100,000 views:
Here’s another one, published on 17 May, 2016, also with over 100,000 views:
Nonetheless, Nvidia’s management, and the analysts covering the company’s stock, acted like they didn’t see the flurry of evidence that the company’s products were being hijacked for crypto-related purposes, artificially pumping up its revenue and margins.
Everybody stuck to the official party line, namely, that Nvidia’s technology was amazing and used solely for things that were making the world a better place: artificial intelligence, DNA sequencing, self-driving cars – you name it.
2017: Nvidia’s complete U-turn on crypto
Finally, during Nvidia’s Q2 2018 Earnings Conference Call, Colette Kress, the company’s CFO, broke the spell during the first part of the call, while announcing the company’s financial results:
“OEM revenue reached $251 million, reflecting sales of our cryptocurrency-specific GPUs, partially offset by the lapse in our licensing agreement with Intel.”Colette Kress, Nvidia’s CFO
This opened the floodgates for analyst questions during the Q&A session. It was August 10, 2017, and the crypto bubble was in full FOMO mode. Neither Nvidia’s management, nor the analysts covering the company’s stock, could ignore the elephant in the room any longer. Mark Lipacis from Jefferies, Toshiya Hari from Goldman Sachs, Craig A. Ellis from B. Riley & Co., and Mitch Steves from RBC Capital Markets buried the management under questions about Nvidia’s exposure to crypto.
In his answers, Jen-Hsun Huang, the CEO, executed a complete U-turn on his own stance from 2014, and boasted about Nvidia’s strong foothold in the crypto mining business:
“Cryptocurrency and blockchain is here to stay. The market need for it is going to grow, and over time it will become quite large. It is very clear that new currencies will come to market, and it’s very clear that the GPU is just fantastic at cryptography. And as these new algorithms are being developed, the GPU is really quite ideal for it. And so this is a market that is not likely to go away anytime soon, and the only thing that we can probably expect is that there will be more currencies to come. It will come in a whole lot of different nations. It will emerge from time to time, and the GPU is really quite great for it.”Jen-Hsun Huang, Nvidia’s CEO
He went on to boast about how Nvidia was on top of things in everything crypto:
Jen-Hsun Huang, Nvidia’s CEO
“Our strategy is to stay very, very close to the market. We understand its dynamics really well. […] We know its every single move and we know its dynamics.
And then last thing that I can say is that the larger of a GPU company you are, the greater ability you could absorb the volatility. And so between the combination of the fact that we have GPUs at just about every single price point, we have such incredibly efficient designs that we’re so close to the marketplace. And because we have such large volumes, we have the ability to rock and roll with this market as it goes.”
The message was clear: artificial intelligence is out, crypto is in.
This can be seen by the number of mentions of crypto during the company’s subsequent conference calls:
2018: Nvidia gets caught with its pants down
From its first admission of being heavily exposed to cryptocurrency mining in August 2017, to September 2018, Nvidia’s shares shot up by another 70%, seemingly immune to the Great Crypto Crash of 2018. During the company’s Q2 2019 Results Earnings Conference Call on August 16, 2018, the company’s CFO seemed very optimistic:
“We had another strong quarter, led by Datacenter and Gaming. Q2 revenue reached $3.12 billion, up 40% from a year earlier. Each market platform, Gaming, Datacenter, Pro Visualization, and Automotive hit record levels with strong growth, both sequentially and year-on-year. These platforms, collectively grew more than 50% year-on-year. Our revenue outlook had anticipated cryptocurrency-specific products declining to approximately $100 million, while actual crypto-specific product revenue was $18 million, and we now expect a negligible contribution going forward. Gross margins grew nearly 500 basis points year-on-year, while both GAAP and non-GAAP net income exceeded $1 billion for the third consecutive quarter. Profit nearly doubled.”Colette Kress, Nvidia’s CFO
Everything was wonderful, the crypto contagion was contained, the company didn’t really have that much of an exposure to cryptocurrency mining after all, please don’t worry.
However, alarm bells had been ringing for some time now. Some analysts had noticed that Nvidia’s inventory was soaring, and suggested that the company might have booked in a little bit too many sales, to make its quarter look good.
Moreover, Nvidia’s management kept saying throughout 2018 that the company’s gaming segment was going strong. But, unless they had the supernatural ability to track which of their GeForce GTX cards were used for gaming, and which ended up in crypto mining rigs, they were in no position to know what was really going on.
Worse, demand for crypto mining had contaminated the gaming market – gamers had to compete with crypto miners, artificially pumping up margins in the gaming segment.
Finally, on November 15, 2018, lightning struck, and Colette Kress, the CFO, had to admit the obvious: crypto wasn’t contained.
“Gaming was short of expectations as post crypto channel inventory took longer than expected to sell through. Gaming card prices, which were elevated following the sharp crypto falloff, took longer than expected to normalize.Colette Kress, Nvidia’s CFO
Our Q4 outlook for gaming reflects very little shipment in the midrange Pascal segment to allow channel inventory to normalize. In Q4, we also expect minimal sales of Tegra chips for game consoles due to the normal seasonal build cycle.”
It was a bloodbath. The company’s shares had already taken a hit from Trump’s trade war antics, but they plunged by another 10% after the earning announcement. From its peak at $290 in early October 2018, the stock more than halved, to $130 a mere two months later.
Nvidia’s next earnings call is next Thursday, on Valentine’s day, 14 February, 2019. Since it’s last earnings call, crypto markets took another big dive, as Bitcoin plunged by almost another 50%, from $6,500 to $3,500. The last three months were a bloodbath for crypto miners. Bitmain itself fired half of its employees just around Christmas. Liquidity disappeared from crypto exchanges, meaning that miners can’t sell anything but the top coins to pay for their electricity bills – and none of these top coins can be mined profitably using Nvidia’s GPUs.
If there was any hope left for the crypto mining business back in November 2018, it’s gone now. I guess we’ll finally see the real effect of the Great Crypto Crash of 2018 on Nvidia’s business. Stay tuned.