Working At Home - Ponzi Scheme Basics

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WHAT IS A PONZI SCHEME?

Ponzi schemes are named after Charles Ponzi who achieved notoriety through his fraudulent “investment” scheme in the early 1920’s. Bernard Madoff who was sentenced to 150 years in prison in June 2009 was running a Ponzi scheme on a massive scale, reputedly costing his victims over $60 billion. In 1920, following his apprehension, Charles Ponzi was sentenced to 5 years in jail!

A so-called Ponzi scheme involves a fraudster persuading people to join the scheme by convincing them that he can achieve outstandingly good returns on their investments. A typical Ponzi scheme works as follows. The crook persuades people to become members of a long term investment scheme with him. Members of the scheme hand over their capital to the plausible crook and receive regular income which is supposed to be interest earned on their investment. It is said that Bernard Madoff promised his victims more than 10 times the return they could have obtained from most legitimate investment sources.

As long as these generous “returns” on their investments are received, the members of the scheme are happy. They might even increase their level of investment and introduce friends and relatives to the scheme. What these people don’t realise is that they are being paid out of the capital invested into the scheme by themselves and other members. The fraudster pockets the majority of the cash and pays members a tiny percentage as monthly “interest”. As long as new members continue to be recruited in sufficient numbers, there will be enough money available to satisfy investors and the scheme can continue. All parties involved are happy until the day dawns when the money runs out.

Some members might even be lucky enough to get their capital returned at the expiry of the term of the agreement; if enough people continue to join the scheme the fraudster will be able to satisfy the demands for capital repayment as well as cover the “interest” paid to keep members happy. The people who actually get their money back are the lucky ones, the scheme eventually collapses when there is no money left because the instigator of the fraud has spent it or invested it elsewhere for his own profit, and there are insufficient new members to inject enough cash into the scheme.

Once the money supply dries up, the Ponzi scheme will collapse quickly. Members who have been blissfully unaware of the fact that they have been the victims of a scam, wake up quickly to the truth when their income suddenly ceases.

Ponzi schemes and "pyramid marketing" schemes are frequently confused with multi-level marketing which is a legitimate business. More information about how multi-level marketing ("MLM") works can be found in our article MLM Basics.