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Ponzi schemes

A Ponzi scheme is a fraudulent investment operation that involves paying abnormally high returns ("profits") to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business.

Charles Ponzi started a scheme in the early 1920’s and the name stuck to this type of scheme. Such schemes have certainly become more refined but the underlying truth is the same- lure people and exploit their desire to make money.

The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going.

The system is doomed to collapse because there are little or no underlying earnings from the money received by the promoter. However, the scheme is often interrupted by legal authorities before it collapses, because a Ponzi scheme is suspected and/or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases.

A Ponzi scheme is essentially a fake investment business and likened to a Pyramid scheme. Investors are paid returns from money raised by recruiting more investors rather than revenues from any genuine product or service.

With no proven track record for the investors, only a few investors are tempted, usually for smaller sums. Sure enough, 30 days later, the investor receives the original capital plus the 20% return. At this point, the investor will have more incentive to put in additional money, and, as word begins to spread, other investors grab the "opportunity" to participate. More and more people invest, and see their investments return the promised large returns.

The reality of the scheme is that the "return" to the initial investors is being paid out of the new, incoming investment money, not out of profits. There is no "global currency arbitrage", "hedge futures trading", or "high yield investment program" actually taking place. Instead, when investor D puts in money, that money becomes available to pay out "profits" to investors A, B, and C. When investors X, Y, and Z put in money, that money is available to pay "profits" to investors A through W.

Do not get carried away buy tall claims of guaranteed high profit returns. Beware of advertisers who do not provide clear-cut details in writing about the nature and scope of the investment. You will see that most of them do not give a clear and simple explanation of the products or services and how the profits will actually be generated. This is evident proof that the business is unlawful.

Therefore, a Ponzi scheme is just another investment rip-off, carefully concealed under the business jargon. It just goes round and round in circles. Finally caves in and the promoters disappear and so does your money.

These promoters look and sound like qualified experts. They will have enough credible sounding reasons to delay your payments and persuade you to reinvest.

The catch is that at some point one of three things will happen:

1. the promoters will vanish, taking all the investment money (less payouts) with them;
2. the scheme will collapse of its own weight, as investment slows and the promoters start having problems paying out the promised returns (and when they start having problems, the word spreads, and more people start asking for their money, similar to a bank run);
3. the scheme is exposed, because when legal authorities begin examining accounting records of the so-called enterprise, they find that much of the "assets" that should exist, do not.

Difference between a Ponzi scheme and a Pyramid Scheme

• A pyramid scheme is a form of fraud similar in some ways to a Ponzi scheme, relying as it does on a disbelief in financial reality, including the hope of an extremely high rate of return. However, several characteristics distinguish pyramid schemes from Ponzi schemes:

• In a Ponzi scheme, the schemer acts as a “hub” for the victims, interacting with all of them directly. In a pyramid scheme, those who recruit additional participants benefit directly (in fact, failure to recruit typically means no investment return).

• A Ponzi scheme claims to rely on some esoteric investment approach, insider connections, etc., and often attracts well-to-do investors; pyramid schemes explicitly claim that new money will be the source of payout for the initial investments.

• A pyramid scheme is bound to collapse a lot faster, simply because of the demand for exponential increases in participants to sustain it. By contrast, Ponzi schemes can survive simply by getting most participants to "reinvest" their money, with a relatively small number of new participants.