What is a Ponzi scheme?

How Ponzi schemes work and how to avoid them


A Ponzi scheme is a type of scam targeting investors. Victims are normally reeled in by promises of extraordinary returns far superior to those offered by traditional financial products.

How does a Ponzi scheme work?

Ponzi schemes tend to follow the same pattern. Enticing advertisements are put out in newspapers and on social media alerting consumers to an investment opportunity. Upbeat, energetic and making bold claims, these ads are designed to make people think that contributing their hard-earned cash is a no brainer.

And, at least at first, those duped into investing may have little reason to suggest something is wrong. They may receive returns described as legitimate profits. Happy that their investment is paying off, they’ll then be enthusiastic about telling their friends and family about the opportunity – innocently hoping they will benefit too.

But behind the scenes, things get murky. The capital contributed by victims isn’t being invested in funds or financial instruments. Instead, the ringleaders of the Ponzi scheme use the cash to pay off earlier investors – or pocket the money themselves. Eventually, the steam runs out of the scam and the ruse is exposed – either when the fraudsters are unable to attract new investors to reimburse old ones, or when large numbers of victims attempt to cash out at once.

Despite the similarities, a Ponzi scheme is not to be confused with a pyramid scheme. In this type of scam, victims are told to aggressively recruit new investors – and in turn, these investors are given targets about how many people they need to bring on board.

Ponzi scheme history

When it comes to Ponzi scheme examples, it’s worth going back to the 1900s and looking at the story of the man who inspired the name for this type of scam: Charles Ponzi. Originally from Italy, he had started to make money through a quirk in the US postal system that was sneaky but legal. Then, he got greedy – and began promoting a scheme that promised investors a 50% return within 45 days, or the chance to double their money within three months. In actual fact, the money was just being recirculated between victims.

Ponzi only managed to get away with his scam for a few months – he was busted by a newspaper investigation and spent just three-and-a-half years in jail. It is estimated his victims lost $20 million at the time, which at 2018 rates would have been worth $250 million. In the years that followed, he struck again.

Other Ponzi scheme examples

The misdeeds of Charles Ponzi have been dwarfed by a plethora of other scams in recent years. Here are three Ponzi scheme examples that collectively cost victims countless billions of dollars:

· Bernie Madoff: An estimated 27,000 people lost a total of $65 billion when his scheme collapsed in 2008 – and many had invested their entire life savings. The fraud was discovered in the aftermath of the financial crisis, and in 2009, he was jailed for 150 years. Although a compensation fund is in place, all those affected will only share a total of about $4 billion. It was the biggest Ponzi scheme in history.

· Ding Ning: The mastermind of the Ezubao Ponzi scheme, one of China’s biggest, used savvy marketing to dupe 900,000 investors out of $9 billion. He was jailed for life in 2017 but only fined $15 million. Another 26 were also imprisoned.

· Tom Petters: Given how his company owned big brands such as Polaroid, Petters was seen as legitimate in the eyes of many investors. But over a 10-year period, he amassed $3.65 billion through an array of Ponzi schemes. He was jailed in 2010 for 50 years – and he won’t be released until 2052 at the earliest, when he will be 95.

How to avoid Ponzi schemes

Before we get on to how to spot a Ponzi scheme, there’s one important thing to remember: these scams affect people rich and poor. In the Madoff scandal, some banks – including Spanish bank Santander and British bank HSBC – lost billions. Other individuals lost tens, if not hundreds of millions of dollars too.

Here are seven top tips to reduce your chances of becoming a victim.

1. There’s no such thing as a free lunch. If you’re thinking that an opportunity is too good to be true, then it probably is.

2. Be wary of guarantees. No investment can provide high levels of returns without risk, irrespective of the economic climate. Exaggerated claims about the money you could make should sound alarm bells.

3. Don’t bow down to pressure. These scammers thrive on rushed decisions and warning that opportunities may be missed.

4. Watch out for vague buzzwords. Complicated financial terms can be common in investments, but often, vague, nonsensical jargon is used to dazzle victims.

5. Don’t take things at face value. A slick website, glowing customer reviews and gatherings in expensive venues may make an opportunity seem credible, but all of this is superficial and doesn’t tell the whole story.

6. Ask questions. A legitimate investment opportunity won’t duck difficult questions about the product they offer.

7. Speak to a specialist. Licensed, independent financial advisors can be invaluable in providing advice on whether you should invest in an opportunity. That said, larger schemes like the one executed by Bernard Madoff clearly slipped through the net.

But what should you do if you think you have already invested in a Ponzi scheme? Here are three further tips to get you started.

1. Cut off contact with the scammers immediately. Make sure you don’t invest any more money and contact the authorities.

2. Talk to your bank. If they know your bank details, action will need to be taken to protect your account. Keep any correspondence you may have, as this could be useful when an investigation is launched.

3. Remain vigilant. The masterminds of Ponzi schemes will often launch new scams after their current one collapses. They are also known to share details about successful targets with associates, or use different identities in order to strike again.

The material provided on this website is for information purposes only and should not be regarded as investment research or investment advice. Any opinion that may be provided on this page is a subjective point of view of the author and does not constitute a recommendation by Currency Com Bel LLC or its partners. We do not make any endorsements or warranty on the accuracy or completeness of the information that is provided on this page. By relying on the information on this page, you acknowledge that you are acting knowingly and independently and that you accept all the risks involved.
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