How DeepSeek caused a financial market frenzy that changed AI forever

When China's first artificial intelligence project entered the public eye, it directly impacted the core of American finance. The emergence of the Chinese startup DeepSeek brought uncertainty to investors, causing Wall Street to lose billions of dollars in less than 24 hours.

At the center of this stock market storm was Nvidia, a darling of the New York Stock Exchange whose cutting-edge chips powered the AI revolution. However, the storm came and went quickly, with the following days proving the market turbulence to be only temporary. But this event laid the foundation for a completely new AI landscape.

Nvidia's technological prowess had propelled the American company to rapid growth, making it one of the world's three most valuable companies by the end of 2024. It had long competed with Microsoft and Apple for the top spot, constantly breaking Wall Street's highest records. In the eyes of investors, the chipmaker was a quintessential American success story, standing at the forefront of the next chapter of the technological revolution. Many believed Nvidia's stock was almost a sure bet.

However, during Monday's trading session on Wall Street, this belief seemed to falter. In less than seven hours before the closing bell, Nvidia's market value lost nearly $1 trillion. Its stock price plummeted by 17%, setting a record for the largest single-day drop in the history of the US stock market. Although Nvidia's stock price rebounded the next day and returned to normal by the weekend, the emergence of DeepSeek had a more profound impact, foreshadowing the imminent intensification of the global AI race.

DeepSeek may have only recently made headlines, but the company is the result of years of quiet work. DeepSeek was founded by 40-year-old AI entrepreneur Liang Wenfeng, who was also the founder of the quantitative hedge fund High-Flyer in 2015. Toby Walsh, an engineering professor at the University of New South Wales and an AI expert, described him as "China's Sam Altman" (the founder of OpenAI), but lacking the latter's charisma. High-Flyer had hired young, bright PhD graduates for algorithmic trading. After apologizing to investors in 2021 for poor performance, Liang Wenfeng seemed to change his strategy.

He founded DeepSeek in 2023, whose employees turned to using chips from the American company Nvidia to develop AI chatbots. However, to achieve this goal, the company had to take a different approach. A year ago, the US government banned Nvidia from selling its most advanced AI processors to Chinese customers to protect America's lead in the industry. This meant DeepSeek had to rely on H800 Nvidia chips to develop its technology, rather than the newer, faster, and more expensive H100 alternatives. Professor Walsh stated, "Many Americans thought this would be enough to tie their hands and stop them from building the most advanced models. But they were proven wrong."

Professor Walsh believes that by cleverly writing software, they were able to build state-of-the-art models using these less powerful, less memory-intensive chips, which explains why DeepSeek was able to stand out. He pointed out that a small, resource-constrained Chinese company was able to create a product that rivals the world's most expensive technology. "American tech giants won't necessarily be the winners," he said. In recent years, the cost of each model has increased exponentially, requiring more data to build. "DeepSeek has shown that if you are smart enough and know how to write algorithms, you can achieve it with an order of magnitude less computing power."

DeepSeek may have become widely known after shaking Wall Street, but the company's AI chatbot was released last December without much attention. Its public release was accompanied by a paper explaining how the robot was created with a small budget of $6 million (A$9.66 million) and older Nvidia chips. At the time, Nvidia's stock price barely fluctuated, and when the latest version of DeepSeek was released nearly two weeks ago, it also did not elicit any response. But by Monday, financial markets panicked. It is unclear what triggered the panic, but there are two main views.

One view is that it may simply be because DeepSeek suddenly dominated the download charts on the Apple App Store. Another view is that the market was reacting to a report by AI investor and analyst Jeffrey Emmanuel, who issued a short-sell recommendation on Nvidia stock, which was shared by some heavyweight venture capitalists and hedge fund founders. In his report, Emmanuel dissected the landscape of the AI field and delved into other companies, such as Groq and Cerebras, that have developed different chip technologies to compete with Nvidia. "Overall, Nvidia faces unprecedented competitive threats, which makes its premium valuation of 20 times forward sales and 75% gross margins increasingly difficult to justify," he wrote. "Perhaps the most disruptive is DeepSeek's recent efficiency breakthrough, achieving comparable model performance at about 1/45th of the compute cost. This suggests the entire industry has been massively over-provisioning compute resources."

In a live interview on X with Bankless HQ on Wednesday, Emmanuel said that while the market expected progress, "they wanted that progress to be somewhat predictable." But his analysis revealed the speed at which other companies were successfully creating fast and reliable chips for AI training and inference, and he said that it wasn't until he pointed it out that anyone really understood. "Imagine creating an air conditioner that is three times more energy efficient, you will gain a huge market share," he said. "It's not just DeepSeek. There are a lot of other threats that people are ignoring, and I don't know why, these people's full-time jobs are to cover Nvidia for Goldman Sachs and Morgan Stanley... how are they not talking about these competitive threats? They certainly did not realize that this would be so important."

While DeepSeek has risen rapidly, doubts have also been raised about its ability to create AI chatbots with less time, money, and energy. Benjamin Picton, a senior market strategist at Rabobank, pointed out that while this low-cost AI platform "disrupted the game," its claims naturally raised questions. "Some analysts have suggested that the model's claimed training costs may be false and that DeepSeek is likely actually relying on American chips it shouldn't have and may not have access to in the future," he wrote on Tuesday. He also pointed out that its country of origin would also raise questions, calling the software "ChatCCP," a moniker combining the rival chatbot ChatGPT and the Chinese Communist Party. "Of course, feeding chat prompts and user details back to Chinese servers for the Chinese government to review is likely to raise national security concerns," Picton said.

Concerns have also been raised about DeepSeek's censorship. The Guardian reported that the platform appeared to be self-censoring when asked about the 1989 Tiananmen Square massacre and why Chinese President Xi Jinping was compared to Winnie the Pooh. DeepSeek's security measures have also come under scrutiny since the company suffered a massive cyberattack on Tuesday. The startup has not released details about the incident, but cybersecurity researcher Aras Nazarovas believes it may have been a distributed denial-of-service (DDoS) attack. "AI companies are relatively vulnerable to DDoS attacks because generating responses to AI prompts requires a lot of server resources," he said. "DeepSeek's move to limit new user registrations suggests it is struggling to prevent its systems from being overwhelmed or further exploited by such attacks."

Nazarovas said the platform's rapid pace of development may have created "weaknesses," and its use of older hardware may also be a factor. "From a cybersecurity perspective, DeepSeek's reliance on less advanced chips is a strategic vulnerability," he added. "Given the ongoing geopolitical tensions between the US and China, especially companies that use less advanced hardware to comply with export controls, may face attacks from state actors and skilled cybercriminals." No organization has publicly claimed responsibility for the attack, and there is no indication that US or Chinese state actors were involved. In addition, the chips themselves have exacerbated geopolitical tensions, as they are manufactured in Taiwan based on Nvidia's designs.

Bloomberg reported on Friday that the US is investigating whether DeepSeek purchased advanced Nvidia chips through a third party in Singapore to circumvent sales restrictions. This comes after another report that Microsoft and OpenAI are investigating whether an organization linked to DeepSeek improperly obtained data from OpenAI. OpenAI is also facing multiple lawsuits alleging the company illegally used copyrighted works to train its systems, but the company denies these allegations. DeepSeek has not commented on either of the Bloomberg reports.

Even before DeepSeek disrupted the market, analysts and amateur investors were questioning the sustainability of the AI-driven financial market boom. But at a tech conference in Las Vegas in early January, Nvidia CEO Jensen Huang further fueled these concerns by launching a series of new products, from gaming chips to desktop computers to AI models that train robots and self-driving cars. His optimism reflected investors' long-held view of the company. They believed that Nvidia held the technology that would shape the future, and they wanted to reap the economic rewards of its monopoly, which pushed the company's stock price to nearly $150 at one point.

However, Roger Montgomery, chief investment officer at Montgomery Investment Management, said it was naive for investors to think Nvidia would not be challenged. "I think it's wrong for any investor or any CEO to think that competition won't emerge," he said. "History is littered with the emergence of new technologies, but in many cases, the ultimate winner is the consumer, not the investors in the new technology. This may be another example of that." Investors have since returned to Nvidia and other AI-related tech companies, and some analysts are beginning to assess the implications for future opportunities in the industry. "I think the initial market reaction was a bit overdone," Amina Rosenberg of Minotaur Capital said on The Business on Wednesday. "DeepSeek has proven that if you reduce costs, you will see more people wanting to use the technology."

Ms. Rosenberg said the volatility and subsequent rebound in Wall Street tech stocks could be a positive development after months of exponential growth in the value of AI-related companies. "I think in some cases, valuations have gotten way ahead of themselves, especially in the US," she said. "When it comes back, it gives people the opportunity to participate in these AI stocks at more reasonable valuations. I also think you will see the scope widen. People are more enthusiastic about software names related to AI, as well as the power infrastructure names related to AI. So, I think the tech sell-off may be positive as it gives the market a breather before moving on to the next stage of the AI journey."

While DeepSeek remains a relatively new player in the competitive AI landscape, it has paved the way for the rapid development of the technology. The company entered the public eye just days after US President Donald Trump announced a $500 billion AI innovation project called "Star Gate," but even he could see the benefits of DeepSeek, telling reporters it was a "positive" development indicating there was a "less expensive way." "A Chinese company releasing DeepSeek AI should be a wake-up call to our industry that we need to focus on competing and winning," he said. "This could be a very positive development. Instead of spending billions, spend less and hopefully find the same solutions."

Former Australian Ambassador to the US, Arthur Sinodinos, said DeepSeek's emergence was a timely reminder not just to the President, but to US tech giants as well. "It's not just a Donald Trump thing," he told The Business on Tuesday. "China has made it clear that they will invest heavily in many high-tech areas. They want to take the lead in many areas such as AI, quantum, and they see these as the basis for the industries of the future. But the point is, it's a reminder that the competitive landscape is much more complex than the US thinks it can dictate to the rest of the world."

Economist and writer Sean Raine believes that DeepSeek will lead to an explosion of AI progress, but he hopes to see a balance between innovation and regulation. "I think there will be a lot of new models coming out in the next six to twelve months," he said on Radio National Hour. "They may be beneficial to humans, but they may also be very dangerous because of censorship. I actually think governments need to step in and say, 'We need to have guardrails, we need to have better regulation.' Because right now, it's all being led by capitalists trying to make money."