A Ponzi scheme is a fraudulent investment scam that promises high rates of return with little risk to investors. The scheme is named after Charles Ponzi, who convinced investors in the early 20th century that they would get a 40 to 50% return on their investment in International Postal Reply Coupons (IPRCs) within 90 days. Early investors received payouts as promised because Ponzi was using funds from later investors to give the promised payouts to earlier investors. The basic premise of a Ponzi scheme is to lure investors and pay profits to earlier investors with funds from more recent investors. The operator pays high returns to attract investors and entice current investors to invest more money. When other investors begin to participate, a cascade effect begins. The schemer pays a "return" to initial investors from the investments of new participants, rather than from genuine profits. Ponzi schemes can maintain the illusion of a sustainable business as long as new investors contribute new funds, and as long as most of the investors do not demand full repayment and still believe in the non-existent assets they are purported to own.

A pyramid scheme is a similar form of fraud that relies on a mistaken belief in a nonexistent financial reality, including the hope of an extremely high rate of return. However, several characteristics distinguish these schemes from Ponzi schemes. In a pyramid scheme, the initial schemer recruits other investors to recruit others (and so on) where new recruits pay the person who recruited them for the right to participate or perhaps sell a certain product. A pyramid scheme recruits other people and incentivizes them to further bring along other investors. A member within a pyramid scheme only earns a portion of their proceeds and is "used" to generate profit by recruiting more people. Pyramid schemes often appear as a legitimate multi-level marketing (MLM) practice, but they involve almost no legitimate sales. Instead, earlier investors are paid from the incoming funds of subsequent investments instead of true profits.