What Does Ponzi Scheme Mean?

The Ponzi scheme is one of the oldest and most infamous scams in the contemporary investment history of the world, a get-rich-quick scheme that many investors fell for in the second half of the 20th century.

Simply put, a Ponzi scheme is an investment scheme created by scam promoters or pushers and offered to investors with promises of little to no degree of risk and consistent returns.

These types of schemes are frequent in the world of cryptocurrency too, as these assets aren’t spared by these malicious actors present within the blockchain ecosystems. Many pushers try to scam novice crypto users into investing in the “next big token” or “the altcoin that will kill Bitcoin” only to have their money taken by these manipulators.

Our article today will focus on what Ponzi schemes are in more depth, the origins of this scheme, and modern versions of Ponzi and pyramid schemes. By the end of this guide, you’ll also learn how to spot one on time and avoid losing cash.

What Is a Ponzi Scheme?

The Ponzi scheme is categorized as a fraudulent investment program. What this means is that the scheme revolves around utilizing payments from later investors in order to pay out original investors, instead of investing the money into the promised investment. The main promise of Ponzi scammers is that they’ll invest the money to generate high rates of return with little to no risk of failure for the investors.

Ponzi schemes end with an inevitable decline in the number of new investors. These scam victims start spreading the word and the scheme is revealed, only too late, as the original scammers have collected the money by then and probably took to flight.

In the world of crypto, Ponzi scammers might even go to such lengths so as to create fake news about billionaires and fictional crypto companies that are waiting for investors just like you. They sell the get-rich-quick scheme by asking you to invest in their ICOs and keep reeling you in until you’re bone dry of crypto.

What Are Pyramid Schemes?

A pyramid scheme is an unsustainable business model in which existing investors make money by recruiting others to execute tasks. Those investors can also find new investors to perform the tasks for them. This way, the ones on top just sit back and wait, while those below them in the pyramid do the tasks required for the scheme’s operation.

The pyramid business model heavily relies on new investors and requires them to make an upfront payment in order to join the investment pyramid. The initial investors take the money invested by these new investors who have been tricked with false promises of large profits if they recruit even more investors themselves and increase the pyramid.

Pyramid schemes often start out with one individual running the scheme. That initial person sits at the top of the pyramid and to start his scheme, he recruits another person and asks of him an upfront payment which would be used to pay out the initial recruiter. The new investor that paid the upfront payments must recruit more people in order to recover from his initial investment and make a profit. He proceeds to recruit more people and the pyramid grows as new investors join the scheme. Each new investor will be asked for an upfront payment and that’s how the profits are turned for earlier investors.

The recruitment process can grow up to a point where the pyramid can no longer support itself and this results in the higher-position investors turning large amounts of profits, at the expense of the latest investors in the scheme who end up losing their investment irrevocably. You can think of pyramid schemes as the financial fraud successors to the original Ponzi scheme.

Who Was Charles Ponzi?

Although these types of investment frauds can be traced back to the 19th century by fraudsters like Adele Sptizeder in Germany or Sarah Howe in the US, the term Ponzi scheme was conceived after a famous swindler born at the end of the 19th century by the name of Charles Ponzi who was even more successful than the two.

Charles Ponzi (1882-1949) was an Italian con-artist and popular swindler in the US and Canada. Ponzi was born and raised in Italy but rose to fame in the early 1920s as a conman in the States for his money-making scheme. His focus was mainly on taking advantage of the US postal system for turning profits and later created his own company called the Security Exchange Company. After his run at scamming investors, he was caught and served prison sentences in the US and Canada, before he was finally deported back to Italy. He spent the remainder of his days living in poverty and occasionally working as an English/Italian translator.

The History of the Ponzi Scam

Ponzi’s original scheme was focused on the US postal service. Back in those days, the postal service offered international reply mail coupons that allowed senders to pre-purchase postage and add it to their correspondence. The receiver would then take the postage coupon and exchange it at their local post office for priority airmail postage stamps, required to send a reply.

This exchange is called arbitrage and Ponzi was generating good profits from running the stamp business by importing cheaper International Reply Coupons from Italy to the US and selling them for a higher price. It all went well until his greed got the best of him as he expanded his operations by creating his own company called the Securities Exchange Company and promised investors a profitable return of 50% in 45 days and 100% in 90 days.

Because he was so successful in the postage stamp business, investors were instantly attracted to his company. However, Ponzi didn’t invest the money that the new investors gave him, instead, he redistributed it to older investors and kept the bulk of the profits for himself.

His scheme operated under the radar until August 1920 when the Boston Post began an investigation for the company he owned due to the many complaints of investors who hadn’t received the promised returns on their initial investments. The investigation uncovered the fraud and he was arrested by federal agents and charged with several counts of fraud.

The Bernie Madoff Ponzi Scheme

Bernie Madoff’s company, the Bernard L. Madoff Investment Securities promised investors large and steady investment returns using an existing investment strategy called a split-strike conversion. Instead of operating the conversion the legal way, Madoff simply deposited the client’s funds into a single bank account that he used to pay investors who wanted to cash out from the company.

His strategy was to fund redemptions by attracting new investors and their assets but things took a wrong turn in 2008 when the stock market went low. He confessed this to his sons who also held high positions in the company and they turned him to the authorities within a day.

The last fund statement said that Madoff had $64.8 billion in client assets. He pleaded guilty to 11 federal felony counts and was sentenced to 150 years in prison, as well as being ordered to forfeit $170 billion in assets. He died in a federal prison hospice in 2021.

Ponzi Schemes Red Flags

Most of the Ponzi schemes share the same characteristics, one of them being too good to be true. We’ll list a few in case you’re ever in the sight of some silver-tongued devil. There are regulations about Ponzi schemes and any investment offer you get that is not corresponding to the U.S. Securities and Exchange Commission should be a major red flag. Experienced investors both in traditional finances, stocks, and crypto may be savvy enough to recognize the red flags but novices might fall into the trap. Here’s a list of some of them:

  1. Promises of high returns with little or no degree of risks.
  2. Overly consistent investment returns.
  3. Unregistered investments.
  4. Unlicensed sellers.
  5. Secretive strategies with complex tiers.
  6. Lack of official paperwork.
  7. Problems with receiving payments.

Basically, when your gut tells you that there’s something fishy going on, you should probably listen to it. If an offer seems too good to be true, in most cases, it’s not. Shady deals, unsavoury characters, promises of wealth and riches might tempt every person, but the most important thing is to remain vigilant and steer clear of hucksters and scammers that follow these traits of operation.

A Few Words Before You Go…

Ponzi schemes have existed for many years, their roots can be traced back to the 19th century making them over 150 years old. Their fraudulent successor, the pyramid scheme has been utilized in every corner of the globe and both types of fraud are still present today.

It would be a pity if somebody falls prey to promises of riches and fame with false crypto companies or Bitcoin killers. These kinds of deals might seem lucrative to newcomers so we’ve written our article to help new users draw a line between potentially valuable crypto assets or a Ponzi scheme involving ICOs and crypto-companies with no background or transparency.

Be wary of schemes that involve these types of operations and you’ll stay safe on the cryptocurrency and investments markets.

Similar Posts

Leave a Reply

Your email address will not be published. Required fields are marked *