The infamous swindler Charles Ponzi inspired the term "Ponzi scheme". It describes a type of financial scheme in which participants are led to believe that they can make large profits quickly. The scheme tricks investors into believing that the profits are coming from legitimate business activities, when in fact they are coming from the contributions of new investors.
The basic idea behind this financial scam is that instead of paying out profits made by the business, early investors get their money back from the money new investors put in. It seems viable while new investors are pouring in, but the plan will eventually fail when the profits promised to earlier members are no longer met. This creates a cycle that eventually collapses because the operator cannot attract enough new investors.
Historical roots and importance in the crypto space
In order to pay rewards to current investors, Ponzi schemes constantly seek to attract new investors. The investment is usually presented as a low-risk, high-return option. Initial investors are rewarded, giving the impression that the business is thriving. Ponzi schemes are characterised by the absence of a legitimate investment vehicle or business.
Ponzi schemes have been reported in various forms throughout history. However, they gained worldwide popularity in the early 20th century with Charles Ponzi's fraud. Ponzi schemes are illegal because they are dishonest in reporting the sources of funds and cause great financial damage. In traditional finance, the Bernie Madoff incident is the largest high-profile Ponzi scheme on record. Madoff ran the scheme for decades until it collapsed in 2008 in the wake of the global financial crisis. The total loss was estimated at $65 billion.
OneCoin stands out as one of the largest Ponzi schemes observed in the cryptocurrency industry. The scheme was orchestrated by Ruja Ignatova, also known as Cryptoqueen. Operating from 2014 to 2019, OneCoin attracted a significant number of investors, reportedly raising a total of $5.8 billion. OneCoin positioned itself as a disruptive innovation, the "Bitcoin killer". Behind the façade of this supposed business was a multi-level marketing scheme. Members were paid cash and OneCoin tokens for bringing in new investors. OneCoin lacked its own blockchain, rendering the coins received or purchased worthless as they were not backed by the promised digital asset technology. Eventually, the US government stepped in and brought charges against OneCoin's leaders. However, Ruja Ignatova disappeared before she could be prosecuted by the authorities.