All right. Hello everyone. I'm Austin Lyons from Chipstrat. With me is Vik Sekar from Vik's Newsletters, and we are bringing you a news flash — a news take from Semi Doped. So this is a little bit different than our regularly scheduled programming. Vik and I decided that, you know, lately every week or so, every couple weeks, there's like just some really interesting stuff that we're like really itching to talk about, and it doesn't always align with our schedule of when we are normally going to record. And so we just thought it'd be fun to have these shorter kind of news take episodes that we bring to you. So, Vik, what is it that made you want to jump on and talk this week? What are we talking about today?
It's this whole Reuters news article about how the Trump administration is proposing to, you know, put a ban on Chinese optical transceivers, and it stirred up quite the panic, you know, in the markets because you really can't build out an AI data center without optical transceivers. And whether people realize it or not, like a bulk of this entire optical component assembly stuff, including the pluggable modules, are actually assembled in China. So it was like quite a shock to everybody, and everybody was scrambling to make out, you know, what's going on here. And at that time I was like, I think we should just cover this at least because it's an interesting thing to talk about because it's just like, what's going on? What if we are cut off from optical transceivers tomorrow? You know, what would happen, or why we think it will actually happen or not happen. So that's why I was like, let's do a news flash today.
Yes, totally, which is good. So let's get into it. You know, I too, I woke up and I read this, and my initial reaction was you can't just cut these off from China immediately because you're not going to backfill that cap supply immediately from the United States, right? So there would be — if you shut it down, there would be a period of time where it's just like, all right, we just have less optical transceivers at the point in time when we're trying to build out data centers, you know, at scales like we never have before. But yeah, walk me through your line of thinking when you read it.
All right. Yeah. So if you're watching this on YouTube, I just have the article up on the screen. So we can actually look at, you know, what's going on here. Essentially, the news that was reported on August 4th says the Trump administration is drafting a ban on US imports of new models of Chinese data center components as it seeks to protect the infrastructure that undergirds the AI boom. Okay, they got some part of it right. Basically, it really is an important part of the AI boom, right? Because you can't — without optical interconnects, you can't do any scale out or like scale across or even like hook up to the data center. You can't even do inference or training or whatever. Like it's a big part of the AI infrastructure, so that's pretty good. So the specific ban actually comes down to Chinese optical transceivers, which we've spoken on this podcast. It just converts light to electricity and back again because light travels much better distances at a much faster rate. So, you know, compared to electrical transceivers, optical transceivers can connect longer distances. So we've done a whole episode on this, the basics of like transceivers and networking and all that, which you should check out if you're wanting to get more into this. So, but the whole thing was that this was the dumbest thing I saw in the article. I'm going to read this out. Okay, like after this, I'm going to ask you what do you think about this because this is like really dumb. It says the move, not previously reported, aims to prevent Chinese firms from stealing data, installing malware, or disrupting service at US data centers which house the chips to train and run AI models. Like, why do you think that, you know, banning the shipment of optical transceivers will prevent the stealing of data and installing of malware? I'm like, that literally has nothing to do with it.
Right. Right. I too was struggling to understand this, and I kind of went down a little bit of a research rabbit hole to figure out like, is this even possible? Like, just so the question is, if a Chinese company assembles an optical transceiver, is that actually a security risk? And so, by the way, I kind of emphasize assembles because at the end of the day, what do these optical transceivers have in them? A lot of times it's a Broadcom or Marvell DSP, it's like retimers, drivers, TIA's, all these various components, a lot of which actually will come from American companies, not necessarily Chinese companies. So, you know, these particular transceiver companies, Innolight for example, or Eoptolink, or these other ones, a lot of it is the assembly and the final kind of cabling and putting everything together. And so the question is like, well, where are they going to put malware? Like, what are we talking about here if they're sourcing a lot of the components? And the one thing I could find is that there's often like a little MCU, like microcontroller, that has some firmware on it, and that firmware can be written to by the vendor. But as far as I could tell, and I would of course, I would love some transceiver person in the industry to tell us more about that. I did find some links. It was like an OIF, Optical Interconnect Forum or something, that had these slides. It was in our Semi Doped Daily. I should have pulled it up this morning, but it was like, okay, it is very — it's a normal thing for optical transceiver companies to have an MCU that has firmware on it and it can be programmed. And sometimes they make it so you couldn't just go in and read it back out yourself to be like, what did they put on here? You know, like I want to audit this. But it's not clear to me that after it gets shipped, they would have any way to get in and upgrade that firmware. So it's not like I could sell you my transceiver and then remotely connect from China and then put all this malware on it and, you know, do something.
These pluggable transceivers don't have too many components, honestly. They have an amplifier on the transmit side and they have an amplifier on the receive side, and then they have some conversion circuits, and that's about it. I mean, then you've got some optical connections like, you know, fiber attach units or whatever if you want to connect to the optical engine. That's it. I mean, what else is here? Like in an optical engine, there's nothing. And then there's like an optic fiber that plugs into it. There's no malware or stealing data or whatever is going on here. You know what's ironic about this is that they want to make this whole ban to prevent the disruption of service at US data centers. The ban would do that.
Exactly. The ban would exactly do what you're trying to avoid.
Yeah. Totally. Totally. So, you do wonder, of course, with things like this. You kind of wonder, is it the government saying, you know, we want to continue to put pressure on China and here's yet one other angle. It's not, you know, Nvidia GPUs. It's somewhere else in the supply chain. Can we put the squeeze on them regardless of whether it's technically sound or not? And in fact, it's a technically complicated area. So if we just tell people, hey, optical transceivers from China are bad. They could have malware. Maybe most people would just believe it at face value. So you wonder how much it actually has to even be true.
Yeah. Yeah. I don't know. I'm not in Washington, DC.
Oh, speaking of Washington, DC. Yes. Yes, I'm glad you said Washington, DC because read this next. 'Transceivers definitely pose a risk,' said this person who's an AI policy expert in Washington, DC. 'As data center buildout scales up, you want to make sure the data center supply chain is secure from the get-go.' Like, you know, again, there's nothing about security in this thing. Like, these components have nothing in them that you can like hack into or like install a virus or something. You know the best analogy I have for this? It's like saying if you hook up this USB cable to your computer, you're going to get a virus.
Like, it's just a USB cable. Like, why would I get a virus? Exactly. You won't. You know, it's a — Right. Right. Yeah. Data just transmits on it. Yeah. I did find — Yeah, I did find this. Okay. It's OIF, Optical Internetworking Forum, and they had this webinar, and there are some slides around like a little MCU on these transceivers for some little bit of firmware stuff. So there is a little bit of trusting the module vendor, but again — and we could put a link in the show notes, but again, it's very unclear that it is an attack vector.
Yeah. Yeah. Actually, there are some management services that actually go on inside, you know, so that's there. Yes, there are some functions that do this kind of stuff. But one other thing is that the biggest company that was hit in China for this is Innolight, right? They seemingly contribute to about 33–34% of the global sales of transceivers, which some analysts actually revised up from what this Reuters article calls to be 27%. So down here it says Innolight has a leading 27% share of the global transceiver market. But some people said it's actually a little bit more than that. And there are others too in the Chinese supply chain who make these things. And if you add them all up, they constitute about 50% of the global optical transceiver market. That is a significant amount of supply to just like ban because you can't get these things anywhere else. And I have to explain what that means because the shares of like Lumentum and Coherent and all these things and Applied Optoelectronics went up when this news came out, but none of these companies, other than maybe Applied Optoelectronics to some small fraction, actually assemble transceivers.
Yeah, I mean, Lumentum and Coherent are still going to make lasers, but they kind of make the hard-to-make, high-end content of an optical transceiver, like the 200-gig EMLs and ultra-high-power lasers that aren't really accessible to too many Chinese module makers or whatever. So what the Chinese module makers actually do is like they work on this very low-margin stuff, but it's a very essential portion of the market, and without them, you can't have optical interconnections in the data center, right? So I don't know how to think about this, but ultimately, if there is nobody to package these optical transceivers into a pluggable module, then I would imagine that Lumentum and Coherent would be upset, like affected by the situation because the sales would go down. So you actually want people shipping pluggable modules, right? So I'm not sure why Lumentum and Coherent went up as soon as the Chinese ban was supposed to show up.
Yes. Okay. So I had that take as well, which is like, okay, look, if there's a fixed supply and then we take the Chinese supply off the table, that doesn't mean that immediately Lumentum and Coherent are going to sell more. They still have a fixed supply, right? And so it's like, okay, maybe like Fabrinet and these other contract manufacturers could try to pull some supply online, and then maybe that would be allocated to the Lumentums, Coherents, and whoever, but none of that happens immediately. So actually just immediately, the only thing that happens is that like now we've traded security concerns for actually building capacity, right? And so this is actually very European in some sense, which is just like, oh no, we're scared about something, let's just put a bunch of regulations and slow down the building of it whatsoever, you know, like because there could be a tiny attack vector that they can often say doesn't really seem possible. Let's just stop building data centers because we just cut off supply to all the interconnect cables.
Yeah. And there's another complicated angle to this because TerraHop, which is actually the non-China arm of Innolight, is actually a subsidiary of the Chinese company Innolight, but they are entirely operated out of Singapore, and they don't have anything to do with China. Like none of the parts come from China, none of the assembly happens in China, everything happens in like Southeast Asia. But now what would you do with those? Like how would you deal with TerraHop? Would you ban them? Would you not ban them? It's a very gray area, so many of these things. And they also said that this ban only applies to new modules, but what does new mean? Like these things have revisions all the time. Like what is new? Like a new slightly different revision, V2 to V3, makes it a new product? Like changing a slight orientation of a part on a module makes it a new product? Like what is it? So I don't think anybody knows. But do you actually think that this is actually going to come into play and actually last?
