A Ponzi scheme is an investment scam where existing investors generate returns via money collected from new investors. The scam was named after Charles Ponzi, an Italian con artist who promised a 50% return within 45 days or a 100% return within 90 days on postal coupons in the 1920s. When something changes hands without a core underlying product or service, it might fall under a Ponzi scheme, thus requiring caution from potential investors.
Understanding a Ponzi scheme
A Ponzi scheme is an investment scam where existing investors are paid with funds collected from new investors.
Though author Charles Dickens had written about similar scams as early as 1844, Ponzi received considerable press coverage on his arrest and he would be forever associated with the scheme.
The most nefarious element of a Ponzi scheme is the belief held by victims that profits are coming from proper business activities such as product sales or investment returns. In the process, they remain unaware that other victims are the source of the funds.
Ponzi schemes operators focus most of their efforts on attracting new investors.
The scheme may run for as long as people continue to invest and are satisfied to the extent that they do not ask to cash out their investments.
Characteristics of a Ponzi scheme
In truth, many Ponzi schemes share a few common characteristics. These include:
Consistent (out of the market) returns
Legitimate investments tend to fluctuate in value as market values increase and decrease.
In a Ponzi scheme, the investment appears to generate positive returns irrespective of market conditions.
Unlicensed sellers (usually not officially recognized)
Investment professionals are required under various state and federal laws to be registered.
Many Ponzi schemes involve unlicensed investors who may claim to be representatives of a real or imagined company.
Difficulty receiving payments (illiquidity)
Despite the apparent success of the scheme, it can be difficult for participants to cash out their investment or realize gains.
Some promoters may tempt them to remain in the scheme with the lure of higher returns in the future.
Secretive or sophisticated strategies (opacity)
The way con artists profit from the Ponzi Scheme is quite simple, but they describe the investment strategy to victims in terms or processes that are difficult to understand.
Others will be vague or tell the individual to keep the investment a secret from family and friends.
Ponzi scheme examples
In the years since Charles Ponzi, investors continue to fall victim to Ponzi schemes despite increased awareness and information around the technique.
Here are just a few examples from the 21st century:
Gerald Payne
Greater Ministries International was an Evangelical Christian ministry headed by Gerald Payne.
Stockbroker and investment adviser Bernie Madoff operated a Ponzi scheme in the asset management unit of his firm Bernard L. Madoff Investment Securities.
FTX seemed to be the most successful crypto trading platform in the world until it turned out to be a big fraud.
FTX is a cryptocurrency exchange platform headquartered in the Bahamas but incorporated in Antigua and Barbuda. The platform was founded by Sam Bankman-Fried who became inspired to make money for the greater social good while studying at MIT.
On a mobile-based trading app, retail and institutional traders can buy and sell futures, options, leveraged tokens, fiat currency, cryptocurrency, and non-fungible tokens (NFTs). Users can receive discounts on trading fees by using the native token FTT.
FTX makes money through various trading fees, including maker fees, taker fees, NFT fees, and margin borrower interest. The company also charges interest on its institutional loan service and collects a fee from merchants that want to accept cryptocurrency as a form of payment.
Sam Bankman-Fried (SBF), defrauded billion of dollars, diverting funds that users had deposited to its platform to another research firm he owned which used those to place wild bets.
The Ponzi Scheme here came in the form of a token called FTT, which was used to create fake liquidity, and enabled SBF to take on a huge amount of loaned money to keep obliterating its Ponzi scheme.
The fact that SBF was running a Ponzi Scheme operation became clear to some already a few months before the FTX collapse.
A Ponzi scheme is an investment scam where existing investors are paid with funds collected from new investors.
Some of the common characteristics of Ponzi schemes include consistent returns, unlicensed sellers, difficulty receiving payments, and secretive or sophisticated investment strategies.
Ponzi schemes continue to occur in the modern age despite increased awareness around the practice. Investment adviser Bernie Madoff is the most notable example having collected almost $65 billion over many decades.
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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
