How can Web3 projects stay away from Ponzi Schemes?

What truly constitutes a Ponzi Scheme is the "mismatch" and "self-circulation" in the financing structure and incentive model.

Written by: Iris, Deng Xiaoyu

Is virtual currency a Ponzi Scheme?

This is almost everyone's first question when they first enter Web3. You can even see on some social media that there is a judgment of "virtual currency is a Ponzi Scheme."

However, such doubts are not without basis.

In the past few years, there have indeed been quite a few projects that, under the guise of "mining rebates", "daily returns", or "stable arbitrage", have built a eyewash through the so-called "Token incentive model". As a result, those who do not understand Web3 or even virtual currency often associate token issuance with Ponzi Scheme.

However, from a legal perspective, attorney Mankun believes that the root of the problem does not lie in the coin itself, but rather: whether this Web3 project has constructed a sustainable economic system, that is, the design of its financing structure and incentive mechanisms.

So, what kind of structure is typical of a Ponzi Scheme? Next, Lawyer Mankun will first take everyone through three common incentive and financing structures in Web3 projects to see how they gradually fall into the Ponzi trap.

Type 1: Typical Ponzi Scheme

Typically, the core characteristics of such projects are very clear: no real products, no external revenue, entirely relying on the funds from new users to fulfill the promised returns to old users, ultimately leading to an inevitable collapse due to a break in the funding chain.

Everything they do in packaging is just putting a new skin on the old tricks of the Ponzi Scheme.

A typical example is PlusToken, which exploded in 2019. This project, which was packaged as "blockchain wallet + quantitative trading," claimed that after users deposited virtual currency into the wallet, the project party would operate funds through "quantitative trading" and provide stable returns of up to 10% per month. At the same time, it set up a multi-level distribution system, where users could earn additional commissions by inviting others to join, forming a clear pyramid structure.

However, PlusToken never disclosed its so-called trading strategy, and the on-chain fund flows did not show any signs of real profits. As subsequent funding became increasingly difficult, the project ultimately collapsed in 2019. According to reports from the Chinese police, the case involved funds exceeding 20 billion yuan, which is a typical case of illegal fundraising and Ponzi Scheme activities.

For example, Bitconnect, which is one of the earliest projects worldwide to be classified as a crypto Ponzi Scheme by regulatory authorities. It claims to be an "automated investment platform" where users can exchange Bitcoin for the platform token BCC and lock it up to participate in the "daily fixed income plan," with an annual return far exceeding 100%.

At the same time, Bitconnect established a complex referral reward mechanism to expand its user base through a multi-level recruitment system, with all profits derived from the continuous influx of funds from new users. However, the project never disclosed the true logic of fund operations, and the "trading bot" remained merely a promotional gimmick. Ultimately, in 2018, after user growth stagnated, the platform suddenly shut down, with tokens plummeting 99%. The U.S. SEC determined that it constituted an unregistered securities offering and a Ponzi Scheme.

These cases together illustrate a problem: when a Web3 project promises "stable returns" but fails to provide real, verifiable products or sources of profit, relying solely on attracting new funds to pay off old investors, it is almost a replica of a Ponzi Scheme.

If the statement "virtual currency is a Ponzi Scheme" holds true, it must be directed at this type of eyewash.

From a legal perspective, such projects not only involve illegal fundraising but may also constitute multiple crimes such as pyramid selling and money laundering. Moreover, they are not "innovations" in Web3, but rather a "Web3 wrapper version" of Ponzi Schemes.

Category Two: Near Ponzi Structure

If the first type is an outright Ponzi Scheme, then the second type appears much "smarter."

They often do not directly promise fixed returns, nor do they have such blatant alluring statements as "daily interest of 10%" or "monthly return of principal." But when you truly analyze its financing structure and token distribution logic, you will find that although this model does not directly appear as a Ponzi Scheme, the underlying logic still plays out the old trick of "later generations taking over the positions of earlier generations."

The most common structure of such projects is: extremely high FDV (Fully Diluted Valuation) and extremely low initial circulation.

For example, a project has an initial token listing price of 0.5 dollars, with a total issuance of 2 billion tokens. Theoretically, its FDV (Fully Diluted Valuation) would be 1 billion dollars.

However, it is important to note that at this time, only about 0.5% of the tokens, or 10 million tokens, which corresponds to an actual circulating market value of approximately 5 million dollars, may actually enter market circulation. In other words, the "1 billion dollar valuation" seen in the market is merely a "book valuation" calculated based on an extremely small circulating supply and does not represent the total funds that the market is truly willing to pay for this project.

In addition, the prices of these circulating tokens are formed through free trading by the initial public offering users and even retail investors entering the market, while private placement institutions may have obtained the tokens at a cost of only 0.01 dollars, and after the token issuance, they only need to wait for the unlocking period to cash out gradually on the basis of dozens of times profit.

Previously, SafeMoon faced a class-action lawsuit due to a similar design. The project created price support through a high tax mechanism (charging high fees for both buying and selling) during its early launch, and heavily promoted concepts like "automatic buyback" and "community lockup" to attract users to continue buying in. Although returns were not explicitly stated, the project team and early KOLs exited at high points by leveraging asymmetric information and price advantages, leaving many community users struggling to "break even" during the bear market.

This constitutes a kind of "structural arbitrage": the initial price is determined by a few individuals through speculation. The project itself has no income, is overvalued, and has very little circulation. Once the high valuation is used as a narrative in the secondary market, later investors become the ones buying at a high price.

However, from a compliance perspective, it is difficult to say that this type of structure is an eyewash, as it neither promises returns nor engages in false advertising. However, its profit logic and incentive design essentially require later investors to bear the costs incurred by earlier ones, completing another form of "Ponzi Scheme". At the same time, once regulatory intervention occurs or user confidence collapses, the project will quickly go to zero, making it difficult for ordinary investors to protect their rights, let alone recover their losses.

Category Three: Ponzi Scheme Tendency

The third type of project often has a real business, team, and product, and the project party tries to complete financing in a compliant manner. However, they still cannot escape another deep-seated problem, which is the imbalance in the design of the incentive mechanism and financing structure, making it easy for the project to be inferred from the results, leading to the project party's "Ponzi Scheme" tendency. This is also the legal risk that we, as lawyers, hope to help the project party avoid.

For example, a GameFi project may have a playable product, thousands of daily active users, and some in-app purchase revenue in its early stages, but it adopts an overly high estimated value in its token model (with a FDV of hundreds of millions of dollars), a very low initial circulation, and allows VCs and KOLs to enter at a very low cost, while lacking sufficient lock-up and transparency mechanisms. Community users, driven by the "product + hype", buy in at high prices, ultimately becoming the ones left holding the bag during the token unlocking wave.

For example, some projects that use the SAFT structure for financing, although they do not explicitly promise returns and possess certain technical capabilities, fail to clearly disclose the pricing and release arrangements for each round during the token issuance process, and the revenue from the protocol cannot support its Token valuation. Once market enthusiasm decreases, the token price drops sharply, causing user losses, a crisis of trust, and even regulatory intervention.

The key issue with this type of project is that the token value is not effectively anchored to real business, and the incentive mechanism cannot be self-consistent in the long term, which may lead to the token issuance becoming overly financialized, causing the entire system to slide towards Ponzi logic under stress tests. Although this type does not necessarily constitute fraud or illegal fundraising, once the market funding breaks, and the token price decouples from the project value, it will still trigger a liquidity crisis. Additionally, from a regulatory perspective, this type of structure may also involve insufficient information disclosure, misleading promotion, and even suspected soft violations of "packaging financial risks with technology."

Although we should not dismiss such projects as a Ponzi Scheme, we must also acknowledge that structural compliance and unreasonable mechanism design are themselves breeding grounds for Ponzi Schemes.

How to Avoid Falling into a Ponzi Scheme?

It can be found that what truly constitutes a Ponzi Scheme is the "misalignment" and "self-circulation" in the financing structure and incentive model. Simply put, if a project cannot generate revenue through real business but relies on constantly bringing in new participants to maintain a superficial prosperity, then regardless of whether it is cloaked in the guise of Web3, it ultimately cannot escape the fate of funding breaks and investor losses.

So, when designing the financing structure for Web3 projects, how should one "avoid suspicion of undeclared"? How can investors identify and avoid structural risks? Lawyer Mankun believes that project parties and investors can start from the following points.

For project parties, the key to building a "non-Ponzi" structure lies in four points:

1. Lower the "book valuation" to avoid the FDV trap. The initial valuation should match the actual business scale and revenue expectations, and should not blindly inflate the FDV to create a false prosperity. Especially avoid inflating the coin price when the circulation is very low, to prevent "air market capitalization" from misleading investors.

2. Reasonably arrange the token release mechanism. The token release pace for all rounds should be equally transparent, avoiding structural mismatches such as "private placement 1% cost - public offering 50 times valuation - community high position接盘". VC, KOL, and core teams should have clear lock-up plans and set reasonable linear unlocking mechanisms.

3. Publish the complete token distribution and release schedule. This should include the price, quantity, lock-up rules, unlocking timetable for each round, ensuring transparency of structure and verifiability of rules. The project party is obligated to provide investors with a clear disclosure of the economic model, rather than using "complex curves" to obscure release risks.

4. Establish a real business foundation. Whether it is protocol revenue, service fees, or NFT sales, only by forming a stable and sustainable business model can the token have intrinsic value support. Ensuring that users' profits come from product growth rather than price games is the fundamental logic to prevent "Ponzi Scheme."

For investors, avoiding the "Ponzi Scheme risk" should focus on three core issues:

1. Where do my earnings come from? Are they from product revenue sharing, protocol incentives, or purely reliant on the next wave of people paying? If the source of earnings cannot be explained with clear business logic, then extra caution is required.

2. Who gets the coins first, and who takes the last? It is important to clearly understand the project's financing rounds, token distribution structure, and unlocking periods. If the token circulation is very low, yet the book valuation is extremely high, and early holders are about to unlock, you might be at the tipping point of offloading.

3. Is the investment rhythm compliant and is the information transparent? The lack of a clear white paper, vague token structure, absence of a price disclosure mechanism, and inconsistent unlocking times—these types of projects often indicate structural instability and information asymmetry, with risks far exceeding the average level.

Virtual currency is not original sin, and token financing is not a natural eyewash. Just like the currently popular track RWA, tokenizing real business data for financing is actually quite appropriate.

For the future of the industry, only by returning to a design that truly links incentives and value can Web3 go further.