Ponzi scheme promoters use money deposited by early investors to pay out the first “dividends”. Investors feel comfortable and decide to invest more. Investors often encourage family and friends to join.
In the end, all Ponzi schemes collapse. They fall apart when the developer spends money too quickly or when the pool of investors dries up.
What is a Ponzi scheme?
A Ponzi scheme is a fraudulent investment scheme. It consists of using payments collected from new investors to pay off previous investors.
Ponzi scheme organizers usually promise to invest the money raised for abnormal profits with little or no risk.
However, in a literal sense, the scammers have no real intention of investing the money. Their goal is to compensate the early investors to make the plan look believable.
As such, a Ponzi scheme requires a steady flow of funds to sustain itself. When the organizers can’t recruit new members or when a large portion of the existing investors decide to raise money, the chain falls apart.
The collapse of Ponzi schemes
A Ponzi scheme is simply a type of investment scam where investors are promised great returns.
Companies that participate in Ponzi schemes focus their full attention on them Attract new customers. Once newcomers invest, the money is collected and used to pay early investors as “returns”.
However, a Ponzi scheme is not the same as a pyramid scheme. In the case of a Ponzi scheme, investors believe they are getting a return on their investment.
In turn, the participants in the pyramid scheme realize that the only way to make a profit is by recruiting other people into the scheme. To a large extent, Ponzi schemes are investment scams.
History of the Ponzi Scheme
The scheme is named after Charles Ponzi, the fraudster who defrauded thousands of investors in 1919.
Ponzi promised a 50% return in three months on profits made thanks to international response coupons. At the time, the Postal Service offered International Reply Coupons, which allowed the sender to pre-purchase postage and incorporate it into their correspondence.
The recipient then exchanges the voucher for a priority airmail postmark at the original post office.
As postage rates fluctuated, it was not uncommon to find that stamps were more expensive in one country than another. Ponzi saw an opportunity in this practice and decided to hire agents to buy cheap international refund coupons on his behalf and then send them to him.
Redeem coupons for stamps that were more expensive than the one for which the coupon was originally purchased. The stamps were sold at a higher price for a profit. This type of exchange is known as arbitration, and it is not illegal.
However, at some point, Ponzi became greedy, inviting people to invest in the company, promising a 50% return within 45 days and 100% within 90 days. Given his success in the postage stamp system, no one suspected his intentions.
Unfortunately, Ponzi didn’t actually invest the money, but rather put it back into the scheme by paying off some of the investors.
How to detect a Ponzi scheme
Most Ponzi schemes have some common features such as:
- The promise of high returns with minimal risk: In the real world, any investment you make involves some degree of risk. In fact, investments that offer higher returns generally carry more risk. Therefore, if someone offers an investment that offers high returns and low risks, it is probably too good to believe. It is likely that the investor will not see any returns.
- Very stable returns: Investments fluctuate constantly. For example, if one invests in the stock of a particular company, there are times when the share price goes up, and other times when it goes down. However, investors should always be wary of investments that offer consistently high returns regardless of volatile market conditions.
- Source credibility tactic: Establish credibility through associations or involvement with reputable individuals or entities or with individuals who have particular credentials or experience, including in the legal, financial, and investment industry.
- Social consensus tactic: We say that others have already invested. This tactic is about creating the appearance of success. This consists of appealing to the herd instinct.
- Reciprocity tactic: Offer to do a small favor in exchange for a big one, such as giving a discount in exchange for an immediate partial investment.
- Scarcity tactic: Create a false sense of urgency by claiming that the supply is limited or for a limited time.
How to protect yourself from Ponzi schemes
In the same way an investor is looking for a company he is about to do stock purchasethe individual should investigate anyone who assists him in this He manages financial matters.
Moreover, before to invest in a project Of any kind, ask for the company’s financial records to verify its legitimacy.
The best way to avoid a Ponzi scheme is to do the following before investing:
- Looking for investmentand see if it is registered with the appropriate regulatory body, or whether or not it is exempt from registration (and if so, why).
- Get information and compare the potential risks and benefits of investing.
- Understand investingand check their details and promoter claims.
- Understand the nature of the core business its operating history, its success rate, the people responsible for its operations, their education, experience, skills, training, and investment history; Obtain annual reports, reviews and financial statements.
- Ask for help and consult a reliable and unbiased third partylike mediator It has nothing to do with the Company, a financial advisor, attorney, or licensed accountant; Get a second opinion.
- Ask for detailed, written information, including information about the company, its officers, and its financial history, investment documentation, including cost, fair market value, current and potential markets, and remedies available to you if you are not satisfied with your investment. Any warranties or refund provisions must be in writing.
- Ask the promoters About their education and experience and about the institutions that have invested with them, as well as the commission, fees or other benefits they will receive from the investment and how it is paid and by whom.
- Do your due diligence ; Conduct background checks and online research regarding the investment and the people and companies involved in the investment.
A Ponzi scheme is simply an illegal investment. Named after Charles Ponzi, who was a fraud in the 1920s, this scheme promises consistent, high returns, but presumably with very little risk.
Although such a scheme may work in the short term, it eventually fizzles out. Therefore, investors should always be skeptical of investments that seem too good to be true.