Ponzi Schemes

Ponzi Schemes

Ponzi schemes have been around for many years, with the fraudulent scheme gaining its name from one of the first notorious schemers (Charles Ponzi). However, Ponzi schemes didn’t reach their peak fame up until 2008, when Bernie Madoff was convicted of running the largest Ponzi scheme to date. Some estimate his scheme lost between $13 billion to over $60 billion (estimates change if the allegedly falsified profits are included). As a definition, a Ponzi scheme is a fraud that occurs when investors are told to invest in a low-risk, but high rate of return investment, who are then paid back supposed “profits” when new investors provide funds. Therefore, the money from new investors are paid back to the older ones, masquerading as profit.

Ponzi SchemesThe person (or persons) running the Ponzi scheme do so in order to pocket as much money as possible. The investors do not know that the high profits they are receiving on their investment (in a fake fund) are actually coming from others joining in. The scheme works properly when those who invest are encouraged to leave their money in the fund and not ask for a repayment. They simply let their investment remain in the fund and collect high returns (based on the false reports they receive). There are no real profits – any returns are merely as a result of a cascade of additional investors. But what happens when that cascade is toppled?

The scheme requires there to be a steady increase of new investors. Otherwise, there is not enough money to pay the fake returns to all of the previous investors. If there is not a large enough flow of new investment, the scheme falls. Another way to ruin the Ponzi scheme is to have its own version of a bank run. If all of the investors demand repayment, the scheme fails to work because their investments have been used, in part, to generate fake profits for others and to replenish the fraudulent lifestyle of the scheme’s operators. Therefore, there is no investment to be repaid. In almost all Ponzi schemes, investors lose most, if not all, of their money.

Those who are looking to invest should make sure they are doing enough research prior to any action. No investment will have a minimal risk with astronomical returns. Moreover, if the investment does not go down when the market is lower, then that’s also a big red flag. Finally, make sure the investment system is transparent and accessible.

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