Ponzi Scheme Definition | CoinMarketCap

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Ponzi Scheme

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A fraudulent investment involving the payment of purported returns to existing investors from funds contributed by new investors.

What Is a Ponzi Scheme?

A Ponzi scheme is a financial fraud under the pretext of an investment opportunity with high returns. The name dates back to the 1920s financial fraudster, Charles Ponzi, who swindled investors out of millions with a fraudulent investment opportunity.

In a Ponzi scheme, early investors are paid with the investments of later investors to keep the scheme going. However, the money is never invested in the promised way, and the system relies on a constant stream of new investors to keep the charade going. Before a Ponzi scheme collapses, some warning signs become visible, like slower processing of withdrawals and missing funds.

How Do Ponzi Schemes Work in Crypto?

Ponzi schemes in crypto often leverage investors' FOMO by promising exceptional returns at very little risk. Since cryptocurrencies are still poorly understood by many investors, these schemes can easily disguise frauds as legitimate investments. Crypto projects often lack third-party audits and detailed information, and many founders choose to remain anonymous. This greatly facilitates Ponzi schemes.

Most crypto Ponzi schemes present a solution to a problem that doesn't exist or exaggerate the solution provided. They always rely on an influx of new investors to pay out old investors. They are, therefore, distinct from vaporware, which does not necessarily promise outsized investment returns, although investors hope they multiply their stakes.

How Do You Spot a Cryptocurrency Ponzi Scheme?

Some cryptocurrency Ponzi schemes can be easily identified. Others are more difficult to uncover. There are a few telltale signs investors should look out for:

Exaggerated Returns at Little Risk: A good rule of thumb is to ask yourself "is this yield possible and where does it come from?" when investing in anything. Ponzi schemes often pay outsized yields without clear evidence of how this is financed. At the same time, the risk is swept under the rug and downplayed compared to the seemingly exceptional opportunity at hand.
Regular Payouts With Low Volatility: Some Ponzi schemes pride themselves on low volatility and regular payouts that far outperform comparable investments. Even though an investment doesn't need to be volatile to be legitimate, consistent returns regardless of market conditions are often a sign that an investment vehicle isn't as legitimate as it claims to be.
Unclear Investment Strategies: Ponzi schemes will often claim secrecy to obscure where funds are going. Investors should clearly understand how the alleged investment opportunity generates its yield. In cryptocurrency circles, a rule of thumb states that "if you cannot identify the yield, you are the yield."
Lack of Information and Liquidity: Not all Ponzi schemes are illiquid and founded by anonymous parties, and not all anonymous founders create Ponzi schemes. But investors need to proceed with caution when their investment restricts payouts or when founders limit the flow of information about the entity.