The cryptocurrency craze has infected the real world economy, driving up the prices of GPUs (graphics chips used for playing 3-D computer games that are also really good at crypto calculations). Mining Ethereum with GPUs has become an increasingly profitable endeavour largely because the price of Ethereum went up about 170 times from $8.24 at the beginning of 2017 to a peak of around $1400. Mid and high-end GPUs are selling out everywhere, retailing for 2 to 3 times their suggested retail price. PC Part Picker has some good data on market pricing of GPUs such as the Radeon RX 570.
Note that computer hardware normally depreciates over time, roughly halving in price every 1.5 to 2 years due to Moore’s Law. Instead of depreciating, most GPUs have appreciated wildly thanks to rising Ethereum prices.
If the crypto mining market collapses (due to a broad collapse in cryptocurrency prices), I am willing to speculate that AMD’s valuation would better reflects its difficulties in generating profits. Historically AMD has never been a particularly profitable company, losing $7.82B of the $8.34B in capital raised. In YE2017 AMD earned $62M before taxes, buoyed by aggressive accounting (perhaps $40M-97M+?) and unusually high GPU demand (perhaps a few hundred million?). If AMD returns to its money-losing ways, its shares ought to trade closer to its $0.611B book value (plus the value of its x86 license) rather than its current $10.83B market cap.
Crypto Mining Demand
For the Bitcoin market, GPUs are no longer used since ASICs (application-specific integrated circuits) are available. While ASICs have high upfront R&D costs, they are far more efficient at cryptocurrency mining since they are designed specifically for a single task. The availability of ASICs has pushed GPUs out of Bitcoin mining. Ethereum is the second largest cryptocurrency by market cap and is the biggest driver of GPU demand. No ASICs are currently available for Ethereum. Ethereum’s design may make ASICs unattractive according to this Ethereum white paper. If the price of Ethereum falls significantly, crypto miners with GPUs can switch to mining other cryptocurrencies.
There are 3 ways in which GPU demand (from crypto mining) can fall:
- A broad sell-off in cryptocurrencies. Crypto mining revenues are directly proportional to the price of the cryptocurrency being mined.
- Ethereum switching to a Proof of Stake system, which would cause Ethereum mining to decrease or die off. Ethereum’s lead developers have indicated their intention of doing this in an upcoming implementation. (It may take a while to happen.)
- ASICs are developed for all of the popular cryptocurrencies.
Like most people speculating in crypto, my understanding of the technology is poor… so don’t put too much weight on #2 and #3. I doubt that any ASICs will be developed for Ethereum. A collapse of the crypto bubble is what I’m speculating on.
There are a lot of everyday people who are now speculating on crypto yet nobody seems particularly interested in the utility of cryptocurrency. You can actually use Bitcoin and other coins to make purchases at a few retailers such as Overstock. The transaction fees are a magnitude higher than Visa and payment takes tens of minutes to clear… so real-world usefulness seems limited. Bitcoin also has a long history of being stolen from exchanges such as Mt Gox. While cryptocurrencies may have utility in illegal transactions, everyday people will likely buy their recreational drugs with cash rather than crypto. It seems obvious that crypto prices are being driven by a speculative mania rather than fundamental value or usefulness.
My speculation is that the large >64% drop in Bitcoin from its peak signals that the overall crypto bubble will collapse soon.
However, that may not be the most reliable signal as Bitcoin survived a >70% drawdown in 2014.
We’ll just have to see if there are more people willing to get off the sidelines and jump into the crypto craze. While I would characterize mainstream participation as high, it could go higher as institutional ownership could reach the levels seen in the Dot-Com bubble. Personally, I don’t see many institutional investors getting into crypto as it’s just too silly.
Ethereum has yet to collapse dramatically in price.
Video card prices
Recall from earlier that PC Part Picker has some good data on market pricing of various GPUs.
The pattern is that most video cards have seen their price steadily increase in January despite Ethereum prices peaking in the middle of January. Note that the market price for GPUs will be related to the price of (A) Ethereum and (B) other cryptocurrencies that can be mined with GPUs- this would explain discrepancies between Etherium and GPU pricing. It looks like GPU pricing will stay elevated for the first quarter of 2018.
A video card’s main costs are the GPU chip and the memory/RAM. Part of the reason why video cards have become more expensive is that memory prices have also increased (again, PC Part Picker has some good data). It is rumored that the 3 big memory producers (Micron / MU is one of them) are engaging in price collusion. This may explain why slower memory undesirable for video cards (e.g. the slowest DDR3 memory) has also gone up in price; the price increases have not been limited to faster memory used for video cards.
I admit that I may be too early in shorting AMD. AMD is likely to have a strong Q1. If the quarter ends with strong GPU demand, it would make sense for management to issue strong guidance for Q2. Perhaps a better idea would be to wait for GPU prices to normalize before betting against AMD.
In the CFO Commentary for Q1 2017, AMD stated that it would begin to capitalize the costs of “production mask sets”. Doing so boosts reported earnings temporarily. On the Q1 conference call, an analyst (Stacy Rasgon) asked management about the capitalized mask costs and management indicated that $40M of the $140M capex guidance was due to mask costs. This should boost the year’s earnings by $40M minus any D&A recognized during the year. The accounting change strikes me as disingenuous as the company does not make an adjustment to Adjusted EBITDA to counteract the change.
If we look at the year-over-year changes in PP&E recorded on the balance sheets (see Q4’s Financial Tables), we see that 2016 ended with $164M in PP&E while 2017 ended with $261M, or $97M higher. If AMD is aggressively capitalizing costs, then earnings could have been inflated anywhere from $40M to $97M. Other Assets is another area where costs can be capitalized. Other Assets grew $31M year-over-year.
The boost from unusual GPU demand is harder to estimate. The “Computing and Graphics” segment revenue went from $1,967M to $3,029M year-over-year, for an increase of $1,062M. That segment’s revenue includes revenues unaffected by crypto mining – budget GPUs, CPUs, CPU+GPU combinations, and other computer chips (workstation GPUs and chipsets). The segment’s operating income increased $385M, resulting in positive operating income for the whole company of $204M. So while AMD earned $62M before taxes in YE2017, that number was boosted by aggressive accounting (perhaps $40M-97M+?) and unusually high GPU demand (somewhere around $385M?). Without changes in accounting and without unusual demand, AMD likely would have bled money during 2017.
The reason why I’m interested in this trade is because it may work out quickly and it may work out shortly after putting on the trade. Having a catalyst makes short positions far more attractive as the rate of return would be higher. There is also a fairly liquid options market for AMD with long-term LEAPs available.
I probably don’t have sensible timing on this trade- it would make more sense to wait for retail video card prices to fall before putting on the trade.
*Disclosure: I own put options on AMD. I am also short OSTK.
Articles about insane GPU prices
CryptoKitties is a collectibles game that runs on Ethereum. Each kitty is unique and can be traded. What actually happens in practice is that users speculate on kitty prices rather than enjoy the merits of really adorable digital cats. To me, this is a sign that the prices are being driven by speculation rather than fundamental value. To be fair, making games on top of Ethereum will lead to a very narrow and skewed audience (crypto speculators).
Some ways to short Bitcoin – Most people who speculate on crypto don’t understand it. I would be one of those people. In the post on shorting Bitcoin, I wrote that the cryptocurrency market drives only a very small portion of the revenues of AMD and NVDA. I wrongly made that assumption.
What to Mine – A great website that calculates the economics of mining various cryptocurrencies.