What is a Ponzi Scam?

A Ponzi scam, in short, can be described as a fraudulent investment scheme that pays investors from their own investments or monies paid by subsequent investors rather than the actual profit earned from investing the monies received.

One earmark of a Ponzi scam is the promised return that no other investment can offer in a short period of time. This fraudulent misrepresentation is made with the aim of enticing new investors to invest in the scheme.

Investors are continuously persuaded to re-invest their capital which is paid out, which ensures that the scheme function longer than other similar scams.

Why Ponzi scams collapse

Ponzi scams are destined to collapse for three reasons. Firstly, the scheme can not guarantee new investors on a continuous basis for the remainder of the period of the scheme. Once new investors fails to join the scheme the Ponzi operation will collapse as there are no new funds forthcoming to pay existing members.

Secondly, at some point in time during the period of the scheme, the amounts of money coming into the scheme will be less than the returns on investments that need be paid.

Lastly, in general Ponzi schemes promote unregistered securities. As more new members sign up to invest in the scheme, the operations are likely to end up under the attention of law enforcement agencies. Subsequently, investigations may result in the collapse of the Ponzi scam before it collapses.

The origin of the Ponzi scam

The exact origin of the Ponzi scam is in not totally clear, but in 1857 Charles Dickens wrote a novel, Little Dorrit. In this book he described some sort of Ponzi scheme. This led us to believe that the Ponzi scheme might have been known at this time.

Charles Ponzi

In 1903 Charles Ponzi, an Italian national, immigrated to the United States. Charles Ponzi started a scheme that was based on arbitraging international reply coupons for postage stamps. He received enormous amounts of money from investors but soon started diverting their investments to support payments to initial investors and to his own personal wealth. Charles Ponzi’s scheme was the biggest ever known in the United States, after which the Ponzi scam was named after him.

What can not be considered as a Ponzi scam?

The following examples are not considered to be Ponzi scams:

Multilevel Marketing

Multilevel marketing is a scheme that rewards members for direct sales of goods and services they establish, as well as the sales of goods and services by other members introduced to the scheme by them.

Stealing funds from investors

Often, when debts are due and no funds are available to service the debts, money are borrowed or stolen from other investors. Debt repayments are then made by this ill-gotten gain.

Multilevel pyramid schemes

A multilevel pyramid scheme is similar to a Ponzi scam, with the exception that in these pyramid schemes investors will only benefit from income if they recruit new members. Failure to recruit new members will result in the fact that they will not receive any payments.

Multilevel pyramid schemes also explicitly states that return on investment capital will only be paid if new members are recruited.

With multilevel pyramids, investors are not required to reinvest their capital paid out to them, which leads to these schemes collapsing much faster than the Ponzi scam.