What the Heck is a Ponzi Scheme?

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With all the talk about Madoff in the news and the Ponzi scheme, I could play ignorant no longer, I had to wiki what a “Ponzi” scheme actually is, I know it is about defrauding investors, but what are the methods that make it the “Ponzi” scheme and how did it get its name?

Well, it turns out a famous person who became famous for this type of fraudulent investment is “Charles Ponzi” who came the United States from Italy in 1903. Charles Dickens actually may have “thought of” the scheme as it is published in the 1857 novel “Little Dorrit” but Charles Ponzi is the person who used the tactics to collect a substantial amount of money in that era.

Note: A Ponzi Scheme is not a MLM (Multi Level Marketing) pyramid, or a bubble scheme.

Here is the basics on how it works:

The seller uses impressive statistics and metrics to entice investors with claimed return rates higher than average on their investment, the initial investors of a Ponzi scheme often make some money initially as the scheme is sold, and then their returns are paid on future investors, in the end all of the money goes bust however.

Since the “schemer” is paying returns only on future investments, there is no actual revenue generated to sustain the rate of promised return, there has to constantly be new investors into the “Ponzi Scheme” to pay the promised returns of the first investors. As more investors participate there needs to be a constant influx of a higher number of new investors just to keep paying the previous ones.

This eventually causes a collapse as new investors aren’t picked up fast enough to pay out the returns of the previous ones, but these schemes often fail far sooner as the government or regulatory agency picks up on them and shuts it all down prior to it running the full course.

If you wiki Ponzi Schemes, at current writing there were over 50 notable Ponzi Schemes performed between 1899 and 2009 currently listed.

There, now you all know what a Ponzi scheme is.

-Justin Germino

Updated: June 29, 2009 — 8:31 am