The Cryptocurrency Move to Proof of Stake Could Be Bad for Nvidia

With the worrying volatility of cryptocurrencies since their April and May highs of this year, it’s not just digital asset speculators that are concerned. In addition, companies that benefit from blockchain bullishness, particularly graphics processor manufacturers like Nvidia (NASDAQ:NVDA) may encounter some choppiness down the line. Indeed, NVDA stock has already printed some hefty red-ink sessions.

As one of the top producers of graphics processing units (GPUs) specifically geared toward cryptocurrency mining — the algorithmic processes that form the decentralized basis of public transactional verification found in multiple blockchain architectures — Nvidia helps undergird crypto-related operations. Without the company and its competitors like Advanced Micro Devices (NASDAQ:AMD), the digital asset sector would not be as robust as it is today.

Naturally, NVDA stock jumped higher during crypto rallies as the underlying technology firm worked overtime to fill mining demand. But the opposite dynamic is also lurking in the shadows. Should virtual currency valuations tumble, that would hurt demand for Nvidia’s GPUs.

Recently, a few articles from Barron’s pointed out this risk for NVDA stock. During bull markets, GPU demand generally rises since blockchain miners and contributors receive digital coins or tokens for their efforts. Logically, if the market price for these coins and tokens jumps higher, contributors earn more profits.

Conversely, if the price falls, then the profit margin for miners decreases. Should the blockchain space find itself in a circumstance where the costs of mining outweigh the profitability, participants will simply abandon their endeavor, much like they did in the last crypto bust cycle (late 2017/early 2018).

To be sure, NVDA stock suffered from the underlying company’s hefty inventory load during the last bubble. With the global semiconductor supply disruption currently, that circumstance won’t be in play. Nevertheless, investors should still be cautious.

The Ethereum 2.0 Risk for NVDA Stock

While the concerns regarding cryptocurrency as it relates to NVDA stock focus on the generally declining market value of digital assets, prospective dip buyers for Nvidia should note that a broader blockchain protocol change could also cloud shares.

As you probably know, one of the most popular cryptocurrencies is Ethereum (CCC:ETH-USD). Not only has it made speculators incredible profits over the years, its underlying blockchain architecture represents the backbone for many other decentralized networks.

But with Ethereum’s shift toward a proof-of-stake (PoS) protocol away from its current proof-of-work (PoW) protocol, this transition poses interesting questions for NVDA stock. Yes, on the surface, PoS is vastly superior to PoW across multiple comparative points, such as efficiency, democratized access to decentralized financial initiatives and perhaps most importantly, environmental footprint.

However, Nvidia doesn’t necessarily seem thrilled at the prospect of this so-called Ethereum 2.0 transition. In its Form 10-K report for the fiscal year ended Jan. 31, 2021, management stated, “Changes to cryptocurrency standards and processes including, but not limited to, the pending Ethereum 2.0 standard may also create increased aftermarket resales of our GPUs and may reduce demand for our new GPUs.”

Why would Nvidia be worried about a more efficient Ethereum protocol? As I’ve previously argued, blockchain projects have two elements: the technical aspect and the economic incentive. But the more important factor could be the latter. If people don’t buy and participate in your blockchain ecosystem, it doesn’t matter how wonderful it is.

More pointedly, Ethereum as a PoS protocol would reduce the profitability margin of miners since the underlying network would become inherently more efficient. Thus, the lack of inefficiency would give miners less work to do.

In turn, this would reduce demand for mining-centric GPUs because PoS protocols inherently de-emphasize hardware for mining purposes.

More a Risk to Cryptos than to Nvidia

Although I can’t prove it, it’s possible that the broader shift toward more efficient blockchain protocols is hurting the digital asset market. Again, if the blockchain becomes more efficient on its own, there is less need for human operators to deliver efficiency. Mining profit margins will decrease, which should negatively affect individual valuations for cryptos that are transitioning to PoS.

Naturally, this will have an effect on NVDA stock. Therefore, if you’re looking for a discount in Nvidia, you may want to wait a bit. More bad news in crypto land could spell a better deal for NVDA buyers.

At the same time, the crypto fallout isn’t a reason to panic on NVDA stock. Because the underlying company has many other revenue channels, if Nvidia were to implode, it won’t be solely due to Ethereum.

On the date of publication, Josh Enomoto held a LONG position in ETH. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.