In this section, we will explore how a Ponzi Scheme works and why it is so effective.
A Ponzi Scheme is an investment scam that pays returns to investors from their own money or the money paid by subsequent investors, rather than from profits generated by the individual or organization running the scheme.
The most common way of running a Ponzi Scheme is to use an investment vehicle with high returns, such as certain cryptocurrencies.
Charles Ponzi is an Italian immigrant who was born Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi in 1882. He was a swindler who became notorious for using the technique of a pyramid scheme to defraud investors of millions of dollars.
Ponzi set up a small office at 27 School Street, Boston in 1919 to sell his business ideas. Later he received letters from potential clients. One of these letters was from a company in Spain that simply asked about the advertising catalog and what it included, leading Ponzi to find a weakness in the system which, at least in principle, gave him an opportunity to make money.
A postal reply coupon was a coupon that compensated for the postage to send a letter from one country to another. Pre-stamped international reply coupons were created with the idea that they could be exchanged for stamps to cover postage costs in the destination country. If these values were different, there was potential to profit from them. After World War I, inflation in Italy made stamps of high value somewhat cheap. U.S. stamps could be had cheaply and exchanged for IRCs of higher worth. Ponzi claimed that the net profit on these transactions, after expenses and exchange rates, was in excess of 400%. This was a form of arbitrage, or profiting by buying an asset at a lower price in one market and immediately selling it in a market where it is priced higher.
Seeing an opportunity, Ponzi quit his job as a translator to set up an IRC scam that would make him money. However, one thing he needed was a large amount of capital to buy the bulk of cheap IRCs from European currencies. But the banks he sought didn’t want to give him the money.
Consequently, Ponzi set up a company (a “scheme”) which would take people’s money and then use it to pay off existing investors by promising them they would get doubled their money in 90 days.Ponzi later increased the time frame to 45 days at 50% interest, thus doubling investments in three months. Banks were only paying 5% annual interest at this point. Postal Reply Coupons offer great returns and are easy to invest in. Some people have been paid off as promised, receiving up to $750 on investments of $1,250.
Ponzi’s scheme ran for over nine months before it collapsed on August 10th, 1920. The day after Ponzi’s arrest, the front page headline on the “New York Times” read “Ponzi Scheme Being Investigated”.
Ponzi schemes are often executed in one of two ways: either through an investment operation where funds are used to pay high returns to older investors or through a pyramid-style operation where new recruits become affiliates who recruit new members, who then must recruit more members to make money for all levels of participants.
The most common form of Ponzi scheme is when the operator offers an investment opportunity with high rates of return, but relies on new investments to continue paying those high rates of return as well
The typical Ponzi scheme will begin by offering an attractive return on investments to lure more people into the “business” and generate a consistent flow of cash. Investors are told they can withdraw whenever they like, but in reality, there is no fund set aside to meet such requests. A few weeks or months after investing, the investor will find out that their money has been used to pay other investors who have requested withdrawals or it has been transferred to someone else’s account or even sent back in cash form (e.g., via Western Union). A Ponzi scheme may also be referred to as a pyramid scheme, a chain letter scheme, or simply an investment fraud.
As we can see, scams are a big problem for the digital world. They are more than just an annoyance. They are hurting people and companies by stealing their money and time.
The future of scams is not clear but it is important to know that there will always be new ways to scam people.
We need to create a new classification for what we call Ponzis in this digital age. We should call them “Ponzi schemes” and “Ponzi-like schemes”.
