What is a Ponzi scheme?
Ponzi schemes are named after Charles Ponzi, an Italian swindler that moved to North America and became famous for his fraudulent money-making system. In the early 1920s, Ponzi managed to defraud hundreds of victims and his scheme ran for over a year. Basically, a Ponzi scheme is a fraudulent investment scam that works by paying off older investors with money collected from new investors. The problem with such a scheme is that investors on the backend will not be paid at all.
A Ponzi scheme in operation would look somewhat like this:
1. A promoter of an investment opportunity takes $1000 from an investor. He promises to repay the initial value along with a 10% interest at the end of a predefined period (e.g., 90 days).
2. The promoter is able to secure two additional investors before the 90 day period is complete. He will then pay $1100 dollar to the first investor from the $2000 collected from investors two and three. He will also likely encourage the first investor to reinvest the $1000.
3. By taking the money from new investors, the impostor is able to pay the promised returns to the early investors, convincing them to reinvest and to invite more people.
4. As the system grows, the promoter needs to find more new investors to join the scheme. Otherwise, he will not be able to pay the promised returns.
5. Eventually, the scheme gets unsustainable and the promoter either gets caught or disappears with the money he has on hand.
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