{"id":217994,"date":"2025-10-22T14:02:11","date_gmt":"2025-10-22T14:02:11","guid":{"rendered":"https:\/\/www.newsbeep.com\/uk\/217994\/"},"modified":"2025-10-22T14:02:11","modified_gmt":"2025-10-22T14:02:11","slug":"should-we-worry-about-ais-circular-deals","status":"publish","type":"post","link":"https:\/\/www.newsbeep.com\/uk\/217994\/","title":{"rendered":"Should we worry about AI’s circular deals?"},"content":{"rendered":"

\"\"<\/a>Art funded by Nvidia and Microsoft<\/p>\n

A week ago, I wrote a post about the possibility of a bust in the AI sector:<\/p>\n

\"America'sAmerica’s future could hinge on whether AI slightly disappoints<\/a><\/p>\n

One aspect of the story I didn\u2019t talk about was the web of \u201ccircular\u201d deals between AI model makers, compute providers, and chipmakers. Almost every news story or blog post that worries about the threat of an AI bust mentions these. Here are some excerpts from a good overview of the situation<\/a> by Emily Forgash and Agnee Ghosh in Bloomberg:<\/p>\n

Two weeks ago, Nvidia Corp. agreed to invest as much as $100 billion<\/a> in OpenAI to help the leading AI startup fund a data-center buildout\u2026OpenAI in turn committed to filling those sites with millions of Nvidia chips. The arrangement was promptly criticized<\/a> for its \u201ccircular\u201d nature\u2026This week\u2026OpenAI\u2026inked a partnership<\/a> with Nvidia rival Advanced Micro Devices Inc. to deploy tens of billions of dollars\u2019 worth of its chips. As part of the tie-up, OpenAI is poised to become one of AMD\u2019s largest shareholders\u2026<\/p>\n

OpenAI confirmed it had struck a separate $300 billion deal with Oracle to build out data centers in the US. Oracle, in turn, is spending billions<\/a> on Nvidia chips for those facilities, sending money back to Nvidia, a company that is emerging as one of OpenAI\u2019s most prominent backers\u2026Nvidia plans to invest<\/a> up to $2 billion in equity in Elon Musk\u2019s xAI in a financing round tied to Nvidia\u2019s chips\u2026<\/p>\n

[Nvidia] agreed to buy $6.3 billion worth<\/a> of cloud services from CoreWeave, which rents out access to Nvidia chips. OpenAI, meanwhile, received $350 million in equity from CoreWeave ahead of the IPO and recently expanded its cloud deals with the company to as much as $22.4 billion<\/a>.<\/p>\n

And here\u2019s their schematic diagram of the deals:<\/p>\n

Here\u2019s a similar article<\/a> in the Financial Times.<\/p>\n

Some people worry that this web of relationships either A) could exacerbate a bust, or B) is a sign that a bust is coming. Here\u2019s an example of the former, from that same Bloomberg article<\/a>:<\/p>\n

[S]ome analysts and academics who\u2019ve tracked the tech industry long enough see uncomfortable similarities to the dot-com bubble. \u201cIn the late 1990s, circular deals were often centered on advertising and cross-selling between startups, where companies bought each other\u2019s services to inflate perceived growth,\u201d said Paulo Carvao, a senior fellow at the Harvard Kennedy School who researches AI policy and who worked in tech in the late 1990s. \u201cToday\u2019s AI firms have tangible products and customers, but their spending is still outpacing monetization.\u201d<\/p>\n

Paul Krugman, meanwhile, thinks circular deals could be the canary in the coal mine<\/a>:<\/p>\n

Third, there is what Azeem Azhar<\/a> calls a \u201cfinancial ouroboros\u201d now taking place in AI: what looks like revenue generated by sales is, in some cases, really just the same stock of money going in circles between the various AI companies\u2026[G]iven the pace at which capacity is expanding, one can\u2019t dismiss concerns that circular flows of money are a warning sign.<\/p>\n

So let\u2019s think about why these circular deals could be a problem. <\/p>\n

Basically, the supply chain for AI looks like this:<\/p>\n

chipmakers \u2014> cloud providers \u2014> AI companies <\/p>\n

Chipmakers like Nvidia make chips and sell them to the cloud providers like Microsoft, who operate the data centers that train and run models for the AI companies like OpenAI. OpenAI pays Microsoft for compute, Microsoft pays Nvidia for the hardware to generate that compute. OpenAI is currently trying to cut out the middleman, creating its own cloud computing capacity. <\/p>\n

Many of the circular deals take the form of an upstream company buying the stock of a downstream company, who then uses that cash to buy products from the upstream company. For example, Nvidia buys stock in OpenAI, which buys GPUs from Nvidia.<\/p>\n

As far as I can tell, there are two main fears about this sort of deal. The first is that the deals will artificially inflate companies\u2019 revenue, tricking investors into overvaluing their stock or lending them too much money. The second is that the deals increase systemic risk by tying all of the AI companies\u2019 fortunes to each other. <\/p>\n

Let\u2019s start with the first of these risks. The question here is whether AI\u2019s circular deals are an example of round-tripping or vendor financing. <\/p>\n

Suppose two startups \u2014 let\u2019s call them Aegnor and Beleg \u2014 secretly agree to inflate each other\u2019s revenue. Aegnor buys ad space on Beleg\u2019s website, and Beleg buys ad space on Aegnor\u2019s website. Both companies\u2019 revenues go up. They\u2019re not making any profits, and they\u2019re not generating any cash flows, because the money is just changing hands back and forth. But if investors are looking for companies with \u201ctraction\u201d, they might see Aegnor and Beleg\u2019s topline revenue numbers go up. If they fail to dig any deeper, they might give both companies a bunch of investment money that they didn\u2019t earn. This is called \u201cround-tripping\u201d, and it happened occasionally during the dotcom boom. <\/p>\n

Now what I just described is completely illegal, because the companies colluded in secret. But you can also have something a little similar happen by accident, in a perfectly legal way. If there are a bunch of startups whose business model is selling to other startups, you can get some of the \u201cround-tripping\u201d effect without any collusion.<\/p>\n

On the other hand, it\u2019s perfectly normal and healthy for, say, General Motors to lend its customers the money they use to buy GM cars. In fact, GM has a financing arm<\/a> specifically to do this. This is called vendor finance<\/a>. It\u2019s perfectly legal and commonplace, and most people think there\u2019s nothing wrong with it. The transaction being financed \u2014 a customer buying a car \u2014 is something we know has value. People really do want cars; GM Financial helps them get those cars. <\/p>\n

So the question is: Are the AI industry\u2019s circular deals more like round-tripping, or are they more like vendor finance? I\u2019m inclined to say it\u2019s the latter.<\/p>\n

First of all, in deals like Nvidia\u2019s relationship with OpenAI, the revenue is only flowing one way. OpenAI pays Nvidia for chips. OpenAI needs chips to perform its core business, which is selling AI services. And Nvidia\u2019s core business is selling chips, especially to people who provide AI services. Both companies are just doing what they\u2019re set up to do. <\/p>\n

Second, these are all big companies that come under intense public scrutiny. Nvidia is a public company, with all of the disclosure requirements and accounting regulations that that entails. While it\u2019s possible that foolish investors might look only at Nvidia\u2019s revenue and not its cash flows when deciding to lend the company money or buy its stock, it seems unlikely that it would make a huge difference. <\/p>\n

In fact, if you look at Nvidia\u2019s stock price, it doesn\u2019t seem to have risen as a result of the big OpenAI deal \u2014 in fact, it\u2019s about the same as it was in August, and showed no visible \u201cpop\u201d after the deal was announced in late September:<\/p>\n

\"\"<\/a><\/p>\n

This really looks to me more like a case of vendor finance. OpenAI is a big company, but it\u2019s not a public company, which limits its ability to borrow and to sell its stock. Nvidia is a public company, and right now it\u2019s the most valuable company on the planet, with a market cap around 9x that of OpenAI. That makes it a lot easier for Nvidia to borrow money \u2014 i.e., its cost of capital is lower. It makes a lot of financial sense for Nvidia to use its low cost of capital to support a more capital-constrained customer. As Azeem Ahar puts it<\/a>:<\/p>\n

Customer demand is fierce\u2014and it\u2019s speeding up. Anthropic\u2019s annualized revenue leapt from $1 billion to $5 billion in under six months, a fivefold jump that signals just how hungry enterprises are for AI capabilities; Google confirmed that demand for its AI services nearly tripled between May and October this year, with token consumption surging across every major product line\u2026<\/p>\n

How can OpenAI possibly match this blistering pace? Nvidia and the hyperscalers have the strongest balance sheets and can effectively use those to expedite the buildout of capacity.<\/p>\n

Now this doesn\u2019t mean deals like this are safe or a good idea \u2014 it only means that these deals are unlikely to represent \u201cfunny money\u201d. <\/p>\n

What about the second risk of circular deals? The more of these deals there are, the more the fate of each of the companies involved depends crucially on what happens to the other companies in the chain. If OpenAI\u2019s business model fails, Nvidia takes two hits \u2014 it\u2019ll lose one of its biggest customers, and it\u2019ll also take a big loss on its equity investment. <\/p>\n

Nvidia was already making a huge bet on the AI industry. Almost all of Nvidia\u2019s revenue comes from data centers<\/a> at this point, rather than from gaming or other lines of business \u2014 and data centers are almost all about AI now. If there\u2019s a giant AI bust, Nvidia will take a huge hit, whether or not it has to write down its stock in other AI-related companies. Basically, with these deals, Nvidia is making a leveraged bet on something that it\u2019s already making an existential bet on. <\/p>\n

And Nvidia isn\u2019t alone here. If AI has a big crash, every single company in the circular deal diagram is going to be either toast or in huge trouble, whether or not they have circular deals in place. The fates of all of these companies are already closely tied together, via their mutual dependence on a single technology. Correlations are already very high here. Tying the companies even more closely together with equity purchases doesn\u2019t really change what will happen if AI itself goes bust. <\/p>\n

What about counterparty risk? All of these companies are utterly dependent on AI, but that\u2019s different than being dependent on one single other company. Even if AI succeeds wildly, Open AI might fail as a company. So we don\u2019t want Nvidia to become too dependent on OpenAI, because Nvidia\u2019s position as the top AI chip company is too valuable to risk. <\/p>\n

This is a real danger. But it\u2019s not clear that the circular deals make things worse \u2014 instead, they might be letting AI companies diversify their dependencies. In the first quarter of this year, more than half of Nvidia\u2019s revenue came from just four big mysterious customers<\/a> \u2014 probably Amazon, Microsoft, and Google, and possibly Meta. Building up demand from OpenAI could help Nvidia be less dependent on those big customers. <\/p>\n

In fact, I suspect that this is what\u2019s actually going on with these circular deals \u2014 diversification. All of these companies are existentially dependent on AI itself, but they don\u2019t want the added vulnerability of being dependent on specific AI companies. So they\u2019re investing in as many of the other big AI companies as they can, in order to diversify away their company-specific risk \u2014 just like when you buy a bunch of stocks<\/a> in order to make your portfolio safer. <\/p>\n

Diversification reduces risk. Leverage increases risk. AI companies are (effectively) borrowing money in order to double down on their risky bet on AI itself. But in doing so, they may also get a bit of diversification. We\u2019ll end up with a system that\u2019s more vulnerable to an AI crash, but less vulnerable to the failure of any specific AI company.<\/p>\n

Essentially, I think the story of these circular deals is really no different than the big macro story<\/a> about the AI boom itself<\/a>. AI is the most promising technology out there, and we\u2019re simply betting a lot of our economy on the hope that we can exploit its full potential. <\/p>\n

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