Ponzi Schemes

A Ponzi scheme, named after an Italian immigrant, Charles Ponzi, who became notorious for using the scheme to defraud thousands in the early 1900s, usually offers abnormally high short-term returns in order to entice new investors. The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going. The system is doomed to collapse because there are little or no underlying earnings from the money received by the promoter.

Several characteristics distinguish pyramid schemes from Ponzi schemes. Ponzi schemes:

• Involve a schemer who acts as a “hub” for the victims, interacting with all of them directly. In a pyramid scheme, those who recruit additional participants benefit directly (in fact, failure to recruit typically means no investment return).
• Claims to rely on some esoteric investment approach, insider connections, etc., and often attracts well-to-do investors; pyramid schemes explicitly claim that new money will be the source of payout for the initial investments.
• Collapse more slowly, because pyramid schemes require exponential increases in participants to sustain them. Ponzi schemes can survive simply by getting most participants to “reinvest” their money, with a relatively small number of new participants.