Ponzi scheme

A Ponzi scheme is investment fraud in which money from new participants is used to pay earlier participants. The returns aren't generated by real profits.

What is a Ponzi scheme?

The organizer often promises high or guaranteed returns. Early participants may actually receive payments. This builds trust and attracts new participants.

Their money is then used to pay earlier participants. The scheme only works as long as new money keeps coming in. When that flow slows down, there are often not enough funds to make payments. Participants may then lose money.

An example of a Ponzi scheme

Suppose an organizer promises an investment with a fixed return. The first participants receive that return, but it doesn’t come from real profits. The money comes from people who join later.

When fewer new people invest, the organizer can no longer make payments. The scheme then falls apart.

Why do Ponzi schemes matter in crypto?

Ponzi-like schemes can occur in crypto projects, for example in DeFi. DeFi is a catch-all term for financial services that use crypto without a traditional intermediary. Fake ICOs, which offer new tokens, can also have similar characteristics.

So watch out for promises of extremely high or guaranteed returns. An unclear business model, secretive explanations, and problems withdrawing funds are also warning signs. A warning sign isn’t automatically proof of fraud, but it does deserve extra attention.

A Ponzi scheme is not exactly the same as a pyramid scheme. In a Ponzi scheme, the organizer usually recruits new participants. In a pyramid scheme, participants have to bring in new members themselves.