A Ponzi is an investment scheme which pays an attractive return, way above what can be earned in the market. The promoter of the scheme pays the attractive return by using the money invested by the new investors to pay the return to the old investors.
Due to the attractive return, the inflow of money from new investors far exceed the payout to the old investors, so the promoter is able to pocket the difference.
Right from the start, the promoter already runs a deficit. For example, the money owing to investors is say $50 million. Next month, $5 million is due to be paid out to the old investors. But if new investors put in $15 million, the promoter can pay out the return and pocket the difference of $10 million. The promoter now owes $65 million to the investors, but there are no funds to back up this obligation.
The old investors may find the return so attractive that they reinvest their savings on redemption.
A Ponzi will continue to grow as more money flows in. When the new money stops coming in, the promoter is likely to run away, leaving the investors with a total loss of their investments.
Read this story about how the Ponzi first started, by a person called Charles Ponzi. As he created this scheme, his name was given to describe the scheme.
http://en.wikipedia.org/wiki/Charles_Ponzi
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