NVIDIA and AMD Have Resolved Their Long-Standing Cryptocurrency Conundrum

Few stories garnered more attention last year than the rise of cryptocurrencies. In just a 12-month span, the aggregate value of digital currency market caps soared from $17.7 billion to approximately $613 billion -- a gain of more than 3,300%. By comparison, the stock market historically returns about 7% a year, inclusive of dividend reinvestment and when adjusted for inflation. That's how unbelieve these one-year returns were.

Questions and conundrums remain

But amid this outperformance has arisen a number of critical questions and quandaries as to where the cryptocurrency revolution heads next.

Perhaps the best known of these quandaries is what I like to refer to as the "proof-of-concept conundrum." This prevailing Catch-22 describes the relatively no-win situation blockchain technology is currently stuck in.

Blockchain -- the digital, distributed, and decentralized ledger underlying most cryptocurrencies that's responsible for processing and recording all transactions without the need for a financial intermediary -- has a chance to be a real game-changer. It could shorten transaction processing times and lower transaction processing costs, among other things, and it has successfully done so in numerous small-scale projects. However, no businesses are willing to give it a go in the real world because it's untested and hasn't proven its ability to scale -- and it'll never be able to prove itself if no big businesses give it a shot. That's the conundrum.

While most of the crypto community and investors have been focused on how to overcome this hurdle, another long-standing cryptocurrency conundrum appears to have finally been resolved.

Graphics cards are a hot commodity

For more than a year now, graphics processing unit (GPU) manufacturers NVIDIA (NASDAQ: NVDA) and Advanced Micro Devices (NASDAQ: AMD) have benefited from a surge in GPU sales as a result of growing demand from cryptocurrency miners.

A cryptocurrency miner is nothing more than a person or business using high-powered computers or servers to solve complex mathematical equations (which are a result of network encryption) in order to validate cryptocurrency transactions as true. These miners are constantly competing against one another to be the first to solve equations for a group of transactions, known as a block. The first to do so is given what's known as a "block reward." This reward is paid out in the tokens of the digital currency being validated. For example, solving a bitcoin block results in 12.5 tokens being awarded. At today's bitcoin token price, that's a greater than $100,000 haul!

Though not all digital currencies are mineable, some of the most popular coins are. These include bitcoin, Ethereum, Litecoin, and Bitcoin Cash, to name a few. With the exception of bitcoin, which requires specialized ASIC chips for mining, most other cryptocurrencies can be successfully mined using GPUs.

Both NVIDIA and AMD have noted that demand for GPUs has been through the roof, reducing their supply and causing the prices of graphics cards to skyrocket. On the surface, this probably sounds like a great problem to have. In other words, if demand is outpacing supply, pricing power remains strong, and both NVIDIA's and AMD's sales should soar -- and soar they have. In their recently reported quarterly operating results, NVIDIA reported 68% gaming division sales growth to $1.72 billion -- GPUs are lumped in as gaming revenue in NVIDIA's report -- while AMD recorded 95% year-over-year growth in its computing and graphics segment to $1.12 billion.

NVIDIA and AMD are putting gamers first...

The conundrum has been that soaring cryptocurrency prices have angered both NVIDIA's and AMD's core gaming customers. Rising graphics card prices have made it difficult for these core customers to upgrade, or even replace their graphics cards, should they need to. NVIDIA and AMD were left with a choice: Either risk their long-term success by alienating their core customer, or increase GPU supply and risk cratering near-term GPU prices (and thusly their own margins). As we now know following their respective quarterly reports, these companies have chosen the latter.

Understandably, meeting GPU demand won't happen overnight. In late March, NVIDIA CEO Jen-Hsun Huang admitted that his company still has a long way to go in an interview with TechCrunch. Said Huang, "We're sold out of many of our high-end SKUs, and so it's a real challenge keeping [graphics cards] in the marketplace for games ... we have to build a whole lot more." AMD has echoed this challenge, suggesting that its ramp-up of GPU production may be limited by the ability of its memory partners to meet demand.

However, making an attempt to increase production should help resolve some of the pricing pressure felt by the gaming community. Since the beginning of the year, graphics card prices have fallen notably off their highs, which should at least give NVIDIA and AMD an opportunity to keep gamers loyal to their respective brands.

...now get ready for the pain

The downside is that NVIDIA and AMD could be facing a pretty steep drop-off in mining-related revenue in the quarters to come. Based on their most recent quarterly reports, NVIDIA noted that about $289 million in sales was derived from mining revenue, while AMD points to about 10% of its total sales ($1.65 billion) being tied to crypto mining, so approximately $165 million.

For their upcoming quarter, AMD is calling for a "modest decline" in crypto mining equipment sales, while Huang believes sales could fall by as much as 67% at NVIDIA, according to MarketWatch. Though we're only talking about 10% of total sales for each company, this smaller sales contributor has been their primary growth driver over the past three to five quarters.

Making matters murkier, cryptocurrency mining tends to be dependent on digital currency prices. If virtual coins are rising in value, the lure of mining increases. Likewise, if virtual coins are dropping, mining margins probably are as well. Since the year began, cryptocurrency valuations have been under enormous pressure. Though there has been a rebound since hitting their lows on April 6, the overall crypto market cap is still down by 33%, year to date, through May 13. This suggests the possibility of demand weakness as GPU supply is increased.

In other words, while NVIDIA's and AMD's cryptocurrency conundrum is being resolved, their respective top- and bottom-line results may suffer.

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Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool owns shares of and recommends Nvidia, but has no position in any cryptocurrencies mentioned. The Motley Fool has a disclosure policy.