What Is A Ponzi Scheme? – Explained in Simple Words

We have been hearing a lot about Ponzi scheme lately but what is really a Ponzi scheme? A Ponzy scheme is actually a fraud-based investment that extracts money from new investors to pay older ones.

ponzi

A Ponzi scheme is characterised by investment based on fraud whereby the individual or firm uses new capital input by new investors to pay as returns to its other investors instead of taking from the profit earned. As such, operators of Ponzi schemes attract new investors with promises of higher short-term returns as bait. Generally, these returns are unusually high and consistent.

Sometimes, legal businesses evolve into Ponzi-schemes-based ones. This might happen when the business finds itself unable to generate the expected returns. From then on, continuing with the Ponzi scheme could be tempting, and the fraud thus continues. It is to be noted that the scam investment is essentially about extracting money wrongfully from investors.

Thereafter, to keep the coffers of the firm full of high returns at all times, new investors have to be lured to pour in more and more capital; as such, the operator finds himself looking out for more prey to bring in money.

From where did the scheme get its name?

The Ponzi scheme earns its name from Charles Ponzi, an individual living in 1920 who was notorious for using that scheme to keep afloat on the market. He delved into the scheme and quickly became well-known in the US.

His strategy involved the arbitrage of international reply coupons for postage stamps. As the business progressed, he became using investors’ money to pay older investors and, obviously, himself as well.

Charles Ponzi was not the one to have invented the scheme though; rather, the fraudulent strategy was well-known even prior to his use of it.

Hiding behind lofty promises

The operator will camouflage his real intents behind ‘slogans’ describing the business as dealing with “offshore investment”, “high-yield investment”, and other such terms. Usually, the lack of knowledge of the market of the new investor will be exploited to the advantage of the operator of the Ponzi scheme. The latter will promote the selling of shares, all the while asking for the transactions to be kept secret.

Ultimately, the operator of the scheme, having collected as much money as he could, does what all robbers do: he disappears leaving his investors without any news of him, or of their money.

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