A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually entices new investors by offering return other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.

The system is destined to collapse because the earnings, if any, are less than the payments. Usually, the scheme is interrupted by legal authorities before it collapses because a Ponzi scheme is suspected or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases. While the system eventually will collapse under its own weight, the recent example of Bernard Madoff powerfully illustrates the ability of a Ponzi scheme to delude both individual and institutional investors as well as securities authorities for long periods: Madoff's variant of the Ponzi Scheme stands as the largest financial investor fraud in history committed by a single person. Prosecutors estimate losses at Madoff's hand totalling $64.8 billion.

The scheme is named after Charles Ponzi, who became notorious for using the technique in early 1920. He had emigrated from Italy to the United States in 1903. Ponzi did not invent the scheme (Charles Dickens' 1857 novel Little Dorrit described such a scheme decades before Ponzi was born, for example), but his operation took in so much money that it was the first to become known throughout the United States. His original scheme was in theory based on arbitraging international reply coupons for postage stamps, but soon diverted investors' money to support payments to earlier investors and Ponzi's personal wealth.

Knowingly entering a Ponzi scheme, even at the last round of the scheme, can be rational economically if government bails out those participating in the Ponzi scheme.