What is Ponzi Scheme

A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi scheme organizers often promise to invest your money and generate high returns with little or no risk. However, in many Ponzi schemes, the fraudsters do not invest the money; instead, they use it to pay early investors and reserve some.
Since Ponzi schemes generate little or no legitimate revenue, they require a constant influx of new money just to survive. They tend to collapse when it becomes increasingly difficult to sign new investors or whenever many of the existing investors cash out.
Ponzi schemes bear the name of the person who, in the 1920s, defrauded investors through a postage stamp speculation scheme.


Ponzi scheme red flags


Many Ponzi schemes share common characteristics. Watch out for these red flags

You are guaranteed a spectacular return with minimal or no risk. All investments entail some level of risk, and an investment that yields results above the norm is likely to pose more risk. Be extremely wary of any investment offering that touts returns as “guaranteed” to deliver some promised outcome.

Consistently high returns-with little or no risk. Investments tend to be governed by fluctuating market conditions. You should be aware of an investment that continues to reap positive returns regardless of favorable or unfavorable conditions in the market.


Unregistered investments. Many Ponzi schemes involve investments that are not registered with the SEC or state regulators. Registration makes a huge difference because it throws open the doors of investors to information about the management, products, services, and finances of a company.


Unlicensed sellers. The federal and state securities laws require investment professionals and firms to be licensed or registered. Most Ponzi schemes involve unlicensed persons or unregistered firms.


Opaque, difficult-to-understand investment plans. If you cannot follow what they entail or do not get all the information you need to make a good investment decision about them, beware.
Paperwork errors. Account statements with errors or alterations may indicate that the money is not being invested as promised.


Difficulty withdrawing. If you don’t receive a payout, or when you do, it’s hard to access your cash, beware. Sometimes, in Ponzi schemes, con artists dissuade participants from taking any steps to withdraw their money by promising spectacular returns for remaining in the scheme.

Understanding Ponzi Schemes


A type of investment scam known as a Ponzi scheme promises investors enormous returns with negligible risk.

The money does not actually get invested. Rather, the scammer focuses his efforts on securing more investors. To generate the payouts in profit claimed by the early investors, the scammer needs to produce an ever-growing pool of victims.

When the influx of new money tapers off, there’s not enough money to pay out those imagined profits. That’s when the Ponzi scheme collapses.

Ponzi Scheme Origins


The Ponzi scheme is named after a scam artist named Charles Ponzi, who, in 1920 became a millionaire by promoting a non-existent investing opportunity.
But Ponzi wasn’t the first to engage in this type of scam. Even earlier schemes were documented in the 19th century, and Charles Dickens dramatized the modus operandi in two novels, “The Life and Adventures of Martin Chuzzlewit” (1844) and “Little Dorrit.”


Charles Ponzi’s first scheme, drafted in 1919, had international mail and the U.S. postal service as its back bone. He received a reply coupon for international postage from a guy in Spain, which was prepaid. Ponzi could cash-in this reply coupon of international postage in the U.S. so that he could send a reply back to Spain. It was this moment when the lightbulb shone bright in the head of Ponzi.


Bernie Madoff and the biggest Ponzi scheme ever


Charles Ponzi did not conduct the last of the Ponzi schemes. Bernard Madoff, convicted in 2008 for operating a Ponzi scheme, concocted reports on his trading so that he could show his clients profits on investments that never existed.

He sold his Ponzi scheme as an investment strategy called the split-strike conversion, which was allegedly the selling and buying of blue-chip stocks and options. Madoff simply used historical trading data as a means of creating fake profits from trading activity that never took place.


Ponzi Scheme Warning Signs


All Ponzi schemes share several characteristics, regardless of the technology used. The Securities and Exchange Commission (SEC) has singled out the following characteristics to look out for:

  • A high return with low risk
  • A return that is fixed regardless of the market fluctuations
  • The investment product is not registered by the SEC
  • The seller is not licensed to sell investment products
  • Secrecy of the investment strategies or are so complicated that one cannot explain
  • No letter from the company to its clients on investment
  • Withdrawing money is problematic 

What is a Ponzi scheme?

Adam promises to pay back a 10% return on a $1,000 loan to his friend Barry. Barry lends Adam $1,000. After one year, he expects to receive $1,100 back. Finally, Adam promises to pay back 10% to his friend Christine. Christine lends Adam $2,000.


With$3,000 in his pocket now,Adam pays Barry his $1,100. He lives off the rest of that money comfortable in the knowledge that, even if he can’t get the money back from Christine before the due date, he will be able to coerce somebody else to lend him the cash.


What’s the Difference Between a Ponzi Scheme and a Pyramid Scheme?

A Ponzi scheme as well as a pyramid scheme depend upon the inflow of the fresh investors being attracted by the high returns achieved by some early investors. A Ponzi scheme pays each investor with money obtained by new investors and makes up fictitious trades by inflating the account of the profits.
A pyramid scheme usually involves a promise of a good business opportunity requiring an initial investment. The scheme lets each investor earn money for bringing in new investors.

The first investors, who invest when the scheme is started, gain the most, earning money for each new recruit that they enlist. As long as there are no longer any prospects left to be recruited, every new recruit will earn less than the last.


How it is a Ponzi scheme?

Ponzi schemes are so named after Charles Ponzi, a businessman who, in the guise of doing so, successfully duped tens of thousands of clients into investing their money in a nonexistent venture for a guaranteed high profit. The money that Ponzi’s earliest clients received came from the contributions of later investors. Before his deception came to light, Ponzi amassed millions.

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