“Phony” means fraudulent, intended to deceive or mislead, counterfeit.
The word does not come from “funny business,” nor from telephone.
The Oxford English Dictionary says that “phony” (British spelling “phoney”) is “probably a variant of fawney,” an old slang term for a finger ring. The OED says “fawney” comes from fáine, Irish for ring. The Irish probably brought the word to America in the 1800s.
Grose’s Classical Dictionary of the Vulgar Tongue says, “Fawney rig, a common fraud thus practised:—a fellow drops a brass ring, double gilt, which he picks up before the party meant to be cheated, and to whom he disposes of it for less than its supposed, and ten times more, than its real value.” This trick was first described by George Parker in A View of Society, 1781.
One London jewelry shop specializing in bogus gold rings did substantial business as a fawney factory. Although the ruse sounds implausible today, many such scams were used to part the innocent and naive from their own gold.
The word “phony” showed up in the US in the late 1800s as an adjective meaning “false”: “Many of the ‘phony’ bookmakers in the ring had not enough play to keep them alive.” (From the Chicago Tribune, June 29, 1893.)