How to Spot a Ponzi Scheme: The Walled Garden Thought Experiment

We still call a lot of crypto projects “Ponzi” just because we observe their prices being pumped and dumped. Although pump & dump projects aren’t themselves Ponzi schemes, they’re market-manipulated scams all to themselves simply because price action is tightly controlled by small collectives of influencers and developers who assigned themselves chunks of the supply. That’s not what we’re here to talk about. These particular things are just prisoner’s dilemmas. Buy-low, sell-high scenarios where as we’ve previously stated: you’re playing chicken with a train you’re not driving.

With that in mind, it’s finally time to talk exclusively about actual “Charles Ponzi style” schemes, along with a cheap & easy way to spot them. Let’s dive in!

Charlie and the Money Factory

The best way to understand the Ponzi scheme is to understand the man who created it.

Born to working class parents and a rather successful family, Charles Ponzi longed for success. Using an inheritance, he went to college to get an education, but rather than studying, he spent like a degen who hit a single 1000x. He enjoyed a lavish life … until the money ran out. So, he did what any degen does when they run out of money and they have no friends left: flee the country and start all over!

He worked hard-labor gig jobs and attempted to cheat and steal in any way he was able. A far cry from the lavish life he once claimed. While trying his hand at banking in Montreal, Ponzi found himself in the middle of a Peter & Paul scam, and during the police investigation, the CEO filled a suitcase with cash, and fled Canada. This is referred to as the Banco Zarossi scam.

Ponzi ripped a bad check off one of Zarossi’s clientele and tried to cash it for $423.58 (adjusted for inflation from 1908 dollars, an amount over $14,000 today). This check fraud netted Charlie his first jail sentence in North America, but it would not be his last.

After a few more stints in jail for petty crimes and inevitably getting married after the end of the first World War, Ponzi struck off on his own and tried his hand at serious import/export. He was far out of his element. His latest venture: Trader’s Guide Magazine, which nobody was willing to pay to be in, because nobody had ever heard of it or read it.

Through his efforts to market the magazine, Ponzi discovered a facet of international business unique to that period in history: the international reply coupon (IRC). Redeemable for an exact value of postage but paid for in differentially valued amounts of FIAT currency, any IRC purchased in one country may be worth more in another by sheer virtue of the arbitrage exchange difference in another country. In effect: Ponzi believed he could spend Italian lira on IRC’s, trade them for US postage stamps worth a higher amount of value in USD, and pocket the difference at scale.

Unfortunately for Ponzi’s dreams, the shipping cost of the IRC more than outweighed any value differential upon receipt in a foreign country, and there were not enough IRC’s in existence to manufacture the kind of profits that Ponzi imagined at scale. This did not deter him in any way, and much like a crypto founder with outsized promises, he pursued the operation to facilitate IRC arbitrage, and began hyping up investors to spend excessive amounts of money financing his postage stamp exchange business.

This hype gave birth to the scheme that now bears his name.

When the Boston Post, which had previously heralded Ponzi as a genius, shipped an analysis by the Wall Street Journal’s Clarence Barron that indicated Ponzi would need to sell 160 million IRC’s (an impossibility due to the fact of only 27,000 IRC’s actually existing) to pay back his investors, the scheme was blown wide open.

Ponzi’s hype machine managed to stem the government’s trade concerns for a time. However, a skilled newspaper publicist hired by Ponzi by the name of William McMasters blasted Charlie’s antics. “This man is a financial idiot,” wrote McMasters at the time according to the Washington Post. “He can hardly add… He sits with his feet on the desk smoking expensive cigars in a diamond holder and talking complete gibberish about postal coupons.”

He kept scamming and getting caught until his inevitable deportation back to Italy where Mussolini felt his financial “brilliance” was enough to try and prop up the dictatorship. After the conclusion of the war, he died in Brazil, destitute and given a peasant’s burial.

The Post’s David Segal says it best: “... Ponzi has really never left us. He is immortal, thanks to a handful of eternal human foibles: greed, foolishness, haywire optimism and the capacity of all people to suspend rational thought in the face of what looks like a major pay-off.”

Walling the Garden

A 3D render of the Hanging Gardens of Babylon, via Britannica

So now that an understanding of the mechanics of Charles Ponzi’s original scheme has been established … how on EARTH does one go about looking for one in the real world, let alone in a crypto project?

It’s actually simpler than you might think!

Clearly, the boom and bust of the 1920’s saw many unsustainable business efforts not dissimilar to the crypto boom and bust of the 2020’s that we’ve already seen and experienced. Arbitraging foreign currencies is very much the bread and butter of daily crypto traders, and the strategies of buying low and selling high generally work well regardless of the FIAT one calls their own (by force or by choice, no less).


The question still remains as to how one can spot a shady business operating in this style.

Picture any business anywhere. They buy things, they may turn these first things into other things if they’re a producer, and then try to sell the end product. Maybe they’re a store or retailer, and their business is the reselling of end products. The reality of the business is irrelevant to the thought experiment.

Is it possible for the business to sustainably generate money and operate without additional spending or investment on its operations? Are they paying themselves exorbitantly, or just the bills and expenses while being unable to generate any cash flow and revenue?

Put more simply: WHERE IS THE MONEY GOING!?

The answer to that question is the difference between a bad business and a Ponzi scheme. For some businesses, this question is easier to answer than others. Let’s use a couple hypothetical examples.

Uncle Jed owns a farm, and every year the farm grows crops. As long as Jed has the ability to keep growing and selling crops, nobody needs to give Jed any new investment money, and Jed can keep selling crops for cash to pay expenses, variable labor, and himself for the effort. Uncle Jed doesn’t run a Ponzi scheme.

Uncle Sam, however, runs a different kind of farm. Uncle Sam calls it a money farm. It’s his … “magic black box.” Uncle Sam needs new people to keep buying his magic money farming box product because otherwise he runs out of money to return to the first buyers. He runs out of this money because he spends lavishly on himself and his scant employees without actually reinvesting in any sustainable business model or considering the safety of the generated revenue. If Uncle Sam had spent money to build anything worth buying or that actually created value, this may not be happening, but, when the new investors stop coming, and the old investors begin cashing out … thus the black box quickly depletes to zero. Uncle Sam ran a Ponzi scheme.

A recent adage in crypto tells the tale, paraphrased thusly: if you cannot locate and comprehend the source of the yield of return, YOU ARE THE YIELDED RETURN. Your money is spent to pay back someone else who bought earlier than you. This is especially going to be true in the land of hyped up scarce assets of speculation, but it is also true in any investment scenario. If there’s no sale, no product, no commerce taking place to generate returns… your new investment IS THE RETURN to the old investor.

But wait, ser! Uncle Sam and Uncle Jed used the same advertising pitch to get my money, and to top that off they still look the same, to me! How do I really tell the difference?

The answer is that you, the INVESTOR, must do research, dive in, and appreciate where the revenues from a business, company, or project are coming from BEFORE you spend money on it.

This requires you to imagine a thought experiment, which we’ll get into constructing … now!

Running The Stress Test: Can They Survive?

The “Walled Garden test” is a thought experiment I envisioned to help myself understand whether or not I believe a business is unsustainable and requires new investment to pay back old liabilities. While not a foolproof test, it is useful in scenarios where one is skeptical of whether one’s financial investment is required to return an old investment to an earlier purchaser. If a business has a model that actually sells products and services for cash flows and revenue, then the business passes the test.

Inspired by McMaster’s and Barron’s work, the Walled Garden test is best utilized using the following framework:

  • An organization is created, proposed, projected, and allocated an investment to begin operations.
  • The organization initiates operations and after a certain point, no additional spending is permitted in outside investment on the organization. It must operate on its own island with the gates closed to new money outside of its business model’s proposed operations.
  • Without any additional financial inputs, and with careful management of resources and capital, can the org sustain operations without needing a loan, future investment, or other additional injection of capital? Is the original proposed plan for value generation enough to continue to allow the org to, at an absolute bare minimum, break even on their initial expense plan?

If the project cannot survive in an environment where future investments are forbidden, then it fails the walled garden experiment. It is effectively a Ponzi scheme in relative terms of time, and as such it requires only time to observe its negative value prospect. If it is not a Ponzi scheme, then it is a business with an unsustainable growth model and it must be immediately reevaluated. A real business does not need to pay back its old investors using new ones. It can do that using revenues generated through service provision and selling desirable products.

Although a simple thought experiment to conduct, it requires actual information about the true propositions of a business or entity. Within crypto, such propositions are fairly easily confirmable. The smart contract not working as advertised in even the most mundane way may forecast severe problems downstream. The advertising having contradictions with the intentions of the founders can also be a red flag. Founders advertising their sports cars while the price rockets downward, for instance.

As with many things in investment, currency, and finance, much risk/reward calculation must be done. Many of Charles Ponzi’s own original investors repeated his refrains, sang his praises and touted themselves as the greatest evangelists for his criminal investment products, and the reason they did so seems hard to fathom: for a time, the products PERFORMED AS ADVERTISED!

The issue with the scheme is, as with any unsustainable business model: time. Through the simple matter of time, the Walled Garden test reveals that if the business remains wholly incapable of growing enough to break even on the initial required investment, it shall remain on the ever-likely dreadful slide to zero that all investment products eventually arrive at, requiring new investors to pay back those who put up their money in hte first place. But recall: even before the end of Ponzi’s original scheme, there was uncertainty; after even Barron’s work could Ponzi continue operating… for a little while.

Some believed his work would yield them the wealth and savings of their dreams. Others never trusted from the start. For a lucky handful who saw their returns and cashed out, Ponzi’s work was exactly what they expected, and some who knew him believed Ponzi acted entirely in good faith; that he genuinely believed his ideas were sustainable and would make everyone wealthy.

The fraud is in the intent. If Ponzi believed genuinely in his skills, he was merely a poor businessman. If Ponzi’s history is any indication, he was a deception artist whose entire persona was constructed of facsimile and misinformation. If you asked me today, he’d fit right in with our Do Kwon’s and Sam Bankman-Fried’s, which is to say: a mythology has been crafted. One that may long outlive the men themselves.

The moral of the story? Business is hard. Sustainable creation of value is hard, and scarcity doesn’t translate directly to infinite wealth. Not everyone can build their own Hanging Gardens of Babylon, analog or digital.

Just ask the man who believed that he could make millionaires out of his friends with 27,000 nickel-sized international postage coupons.

P.S. to any FIAT maximalists who stumble onto this piece: scarcity is not the only value proposition behind $BTC and $ETH. Rigid supply inelasticity helps, too.

Thanks for making it this far, and I sincerely hope you enjoyed this piece and found it valuable. If you want to read more like it, please go visit the Discord server, check out the fantastic community at and shout at @oknu about more content. He loves it when you do that.

Stay safe and stay curious, out there!