SHANGHAI (BLOOMBERG) - Almost overnight, Ding Ning and Zhang Min struck it rich with the hot new thing in Chinese finance. In 18 short months, they transformed an old-line industrial company into an Internet phenomenon through the seeming magic of peer-to-peer lending.

It was all a lie - a vast Ponzi scheme that appears to have been orchestrated by the Bernie Madoffs of China. The story thus far is a tangled tale that stretches from China's fertile heartland in Anhui province to the war-torn reaches of northern Myanmar to the palm-fringed streets of Beverly Hills.

Just where it will end is still anyone's guess. But already China's regulator has warned that the explosive growth of so-called P2P lending - not only in China, but around the world - means other problems could be lurking out there, too.

"It was just a matter of time before we saw something this big keel over," said Mr Zennon Kapron, managing director of Kapronasia, a consulting firm based in Shanghai.

The alleged scheme involving Ding, Zhang and their assorted associates unravelled this week after a months-long investigation into their Yucheng Group and its P2P platform, Ezubo, which had been celebrated as a new model for financial services.

The numbers are staggering: The authorities say Ezubo defrauded more than 900,000 people out of the equivalent of US$7.6 billion (S$10.7 billion) by promising them returns as much as 10 times higher than the official deposit rate. That would make it the largest Ponzi scheme in Chinese history.

Ezubo's model, allowing the online public to invest in underlying assets in leasing contracts and get returns from the cash flow paid by lessors, made it one of the country's more than 3,600 peer-to-peer lenders.

The industry has drawn unlikely companies, such as nail and screw maker Yucheng Group, to an exploding frenzy of lending totalling 982 billion yuan (US$149 billion) in 2015, almost quadruple the amount in 2014. More than 1,000 of these so-called P2P firms are "problematic", the China Banking Regulatory Commission said in December when it announced draft rules to restrict such lenders and pledged to "cleanse the market".

China's plan in allowing online lenders to flourish was to allow additional ways for small business to get financing rather than turn to back-alley shadow bankers - a shady world that was flourishing outside of government control when P2P lending began taking off in China in 2012 and only 3 per cent of China's 42 million small business owners could get bank loans.

Online lending was a way for the government to encourage further economic stimulus in an economy growing at the slowest rate in a quarter century, and in theory it should be more transparent to regulators because it uses a real-time digital ledger of accounts.

"I think the government allowed this all to happen because it was desperate to pump money into the private economy as all the other slowdowns started to happen," Mr Steve Dickinson, a Qingdao-based lawyer for Seattle firm Harris Moure PLLC, said by e-mail. "It is likely that the regulators at the top simply turned a blind eye to the risks in the desperate hope that this kind of lending vehicle would get them through a rough patch."

Invented Projects For Ezubo, which translates as "easy-to-lease", almost 95 per cent of investment projects listed on the website touting annual returns from 8 per cent to 14.6 per cent don't exist, and among the 207 lessors it claimed to work with, only one had done business with it, according to the official Xinhua News Agency.

Ding said in a confession broadcast on Monday (Feb 1) on state-run China Central Television that he had embezzled about 1.5 billion yuan from company accounts, and most of the money was from Ezubo. He also gave 550 million yuan raised on Ezubo to Zhang, Yucheng's president and his girlfriend, citing "personal reasons", on top of a 130 million-yuan villa in Singapore, a 12 million-yuan pink diamond ring, an emerald necklace and several luxury cars, he said.

Just a few months before the blowup of Ezubo, state media was still giving the lender glossy coverage. At an industry conference hosted by Ezubo in June, government officials, corporate leaders, and legal experts discussed the development of Internet finance and risk prevention, and lauded Ezubo's business model.

The company promoted itself with campaigns including TV commercials and logos on seat covers of the Shanghai-Beijing high-speed train. Its message conveyed a company that sought to advance Chinese President Xi Jinping's vision of raising the contribution of direct financing to support the economy.

Ding, the 34-year-old chairman of Yucheng Group and its related companies, also had international ambitions. In November, Chinese entertainment executive Bruno Wu unveiled a new, US$1.6 billion fund to finance Hollywood movies in cooperation with Yucheng Group at an exclusive dinner with Los Angeles producers at the W Hotel in Beverly Hills, according the Hollywood Reporter.

In an e-mailed response to questions, Mr Wu said he dropped the deal before it was finalised and expressed "shock" at the confession. Yucheng Group's telephone number is no longer working.

Yucheng Group had also opened a bank in Myanmar's unrecognised Wa state, an area along China's border and disputed in a long-running civil war, China's Caixin magazine reported.

In early December, when Ding and Zhang realised that new investment inflow could no longer meet interest payments for the old investors, they started to move assets, destroy evidence and prepare to run away, according to their confessions.

On Dec 8, local police from various areas coordinated an operation to arrest 21 employees of Yucheng Group including Ding Ning. The police used two excavators and dug for 20 hours to unearth 80 bags of documents that Ezubo executives had buried six metres underground on the outskirts of Hefei, a city in the eastern province of Anhui, Xinhua reported.

The police investigation found the company had spent as much as 800 million yuan to buy corporate details from brokers and used the information to fabricate investment projects. Among Yucheng Group's numerous units, only three - including one making nails and screws - brought in profits totalling less than 100 million yuan in an unspecified period, far from enough to cover Ezubo's massive expenditures, according to Xinhua.

Premier Li Keqiang and President Xi have been seeking to remodel China's economy, urging development of new industries such as Internet finance to ensure easy flow of credit without inflating financial-system risks. They can ill afford more high-profile blowups in the P2P industry.

"The Chinese government is supposed to be seeking stability," said Mr Dickinson, the lawyer. "This type of wide-spread financial disaster is obviously not supportive of stability."