The Hidden Risk Behind the AI Boom: Circular Financing Explained

The global AI boom is one of the most powerful investment themes of this decade. From chipmakers and cloud providers to data centers and enterprise software, the scale of capital flowing into artificial intelligence is unprecedented. Companies are reporting strong growth, order books are expanding and valuations continue to re-rate higher.

But beneath this visible growth lies a less discussed reality, one that could shape the durability of this entire cycle. A growing part of the AI ecosystem is being driven not just by demand but by how that demand is being financed and at the center of this is a structure known as circular financing.

What is Circular Financing?

At its core, circular financing is a closed-loop funding mechanism. A supplier, typically a chipmaker or cloud provider, either invests in, lends to or financially supports its customer. That customer then uses the same capital to purchase infrastructure, hardware or services from the supplier. In simple terms:

Supplier funds customer → Customer buys from supplier → Supplier books revenue 

This creates a system where growth is not entirely organic; it is partially engineered through capital flows.

How the AI Ecosystem is Using It

The AI value chain today is tightly interconnected:

• Chipmakers supply GPUs and AI hardware
• Cloud providers offer infrastructure and computing power
• AI firms build models and applications
• Financial institutions fund expansion

What is changing is the degree of financial interlinking between these players.

In several large deals globally:

• Technology suppliers are taking equity stakes in AI startups
• Long-term purchase agreements are being signed upfront
• Financing support is extended to accelerate infrastructure build-out

This creates a powerful loop:

• Startups get access to capital and compute
• Suppliers secure long-term demand
• Banks see visibility and extend more credit

On the surface, this looks like a well-functioning growth ecosystem. But structurally, it is far more dependent and interconnected than it appears.

Why Growth Looks Strong — Even When It May Not Be

Circular financing has one key effect: it amplifies growth signals.

• Revenues rise due to committed contracts
• Order books expand rapidly
• Capacity build-out accelerates
• Valuations re-rate based on visibility

However, an important question emerges: How much of this demand is truly end-user driven and how much is capital-driven? When funding and demand originate from the same ecosystem, revenue quality becomes harder to assess. This is where the concept of round-trip growth becomes important.

Round Tripped Growth: The Core Concern

In circular structures, capital often flows in a loop:

• Investment or credit originates from a supplier
• It is deployed by the customer
• It returns to the supplier as revenue

From an accounting standpoint, everything looks legitimate. From an economic standpoint, however, this raises a key concern: Is the growth sustainable without continuous capital injection? This distinction between reported growth and underlying demand becomes critical in evaluating long-term value.

The Fragility Beneath the Momentum

Such systems tend to work extremely well until they don’t. The risks are not immediate, but they are structural:

• If AI adoption slows, capacity may remain underutilised
• If monetisation lags, cash flows may not justify investments
• If one major player faces stress, it can ripple across the ecosystem
• If funding tightens, the entire loop can weaken simultaneously

This creates a scenario where the system is highly efficient in expansion but vulnerable to slowdown.

A Familiar Pattern: Lessons from the Telecom Bubble

History offers a useful parallel. In the late 1990s telecom boom:

• Equipment providers funded telecom operators
• Operators used that capital to buy infrastructure
• Revenues and growth appeared strong

But much of the demand was credit-driven, not consumption-driven.

When actual usage failed to match expectations:

• Debt levels surged
• Defaults increased
• Vendors had to write off large exposures

What looked like a structural growth story turned out to be a financing-led expansion cycle. The AI ecosystem today is not identical, but the pattern of capital-supported demand is comparable.

Why This Cycle is Different — But Not Risk Free

It is important to maintain balance. 

Unlike past bubbles:

• Leading AI companies are highly profitable
• There is genuine demand across industries
• Infrastructure investments have real utility
• Adoption is already underway

However, even real demand can be overestimated or front-loaded.

The current cycle involves:

• Massive upfront capex
• Rapid capacity expansion
• Expectations of future monetisation

Which introduces a key challenge: Timing mismatch between investment and returns

The Capex vs Cash Flow Gap

AI is fundamentally a front-loaded investment story. 

• Billions are being spent today on chips, data centers and infrastructure
• Returns are expected over several years
• Monetisation models are still evolving

This creates a lag: Capital today → Revenue visibility → Cash flows later

If execution delays occur or demand grows slower than expected, this gap can widen, putting pressure on balance sheets and valuations.

What Investors Should Focus On

In such an environment, traditional metrics may not be sufficient.  Investors need to go deeper and evaluate:

• Quality of revenue (contract vs consumption)
• Cash flow conversion (not just top-line growth)
• Capital intensity (how much is being reinvested)
• Customer concentration risk
• Funding dependencies within the ecosystem

The key is to distinguish between: Sustainable growth vs capital-supported momentum.

Conclusion

The AI boom is real. The productivity potential is undeniable. The long-term impact will be transformative. But the way this growth is being financed adds a layer of complexity that cannot be ignored.

Circular financing is not inherently negative; it can accelerate innovation, enable scale and unlock new ecosystems. However, when capital starts driving demand, rather than demand driving capital, the structure becomes fragile.

The real opportunity for investors lies not in chasing the AI theme blindly, but in identifying where growth is genuine, cash-flow backed and sustainable.

Because in every major cycle, the winners are not those who follow momentum but those who understand what is truly driving it.

Disclaimer: The article is for informational purposes only and not investment advice.