Ponzi schemes are some of the most popular types of scams out there, always seeming to come back in one way or another over the years. But what exactly is a Ponzi scheme, how can you detect one, and what can you do if you’ve fallen victim to one of these plots?
The term Ponzi scheme originated around 1920, with a grifter named Charles Ponzi having the honor of the scam being named after him. But these types of schemes were around long before Ponzi got involved, with the first officially-noted instance taking place in the mid-1800s.
For his part, the original Ponzi involved the U.S. Postal Service, promising investors significant returns on pricey international postage. Ponzi claimed that he could buy and sell international postal reply coupons, kind of like a postage reply envelope. His story to investors was that he could buy coupons in bulk from overseas at a significant discount, then sell them in the U.S. for a quick profit.
He claimed that investors could make 50% profit in 45 days and 100% in 90 days. However, he did not invest any of the money in coupons. Instead, he delivered on his promise of handsome profits by using money from new investors to pay existing investors. His success was self-fulfilling—investors that had profited helped recruit new investors, so the scheme grew.
Ponzi was eventually convicted of mail fraud and jailed in 1920.
Ponzi schemes can be very difficult to detect. The lure of what appears to be a proven track record, significant returns in a short amount are so tempting and are the main reason why this type of scam has been around for such a long period of time.
"Don't invest in something that you don't understand"Warren Buffet
Warren Buffet, the billionaire investor, uses the mantra "don't invest in something that you don't understand." This advice couldn't be more relevant to protect yourself against Ponzi schemes. If the returns look too good to be true and you don't understand how the business makes money, don't invest —it could be a Ponzi scheme.
Regardless of the institution involved, every version of Ponzi schemes follows the same general script.
Ponzi schemes start with the promise of a high—and, typically, fast—return on investment, for virtually no risk. In the case of Ponzi, investors were promised as much as a 50% return on their money in under two months.
But rather than use that money to generate the returns in legitimate ways, the incoming investments are parceled out to pay earlier investors, who are told that what they’re receiving are their own returns. Ultimately, the scammer wants to make easy money, skimming off the top of every “investment” before simply pushing the remainder forward.
Of course, to keep the cycle going, a constant stream of new investors must be tapped. This usually proves impossible, though, and at some point, most schemers will see the writing on the wall and try to take the money and run.
Alan Greenspan used the phrase "irrational exuberance" in a 1996 speech, which describes one of the key tenants of a Ponzi scheme. The concept is that when people observe other people making money (exuberance), it gives them confidence that the investment is safe (irrational). Of course, the other common feature of a Ponzi scheme is higher than average returns or better returns than you would expect from the market.
Some Ponzi schemes use exclusivity or scarcity to attract investors by having some minimum criteria to invest. This could be financial, or it could be only giving access to certain exclusive groups. All of the victims of Ponzi schemes share one thing in common, which is critical for the scheme to run successfully and that is that they are investing into something that they don't understand. This video gives a summary of the mechanics of a Ponzi scheme.
Bernard Madoff was behind the biggest reported Ponzi scheme of all time, worth a reported $65 billion. Madoff was a prominent businessman and founder of Madoff Investment Securities. The incredible part is the scheme had been running undetected for over a decade and only unraveled when Madoff confessed to his two sons, who told the FBI.
Bernie Madoff is infamous for the largest Ponzi scheme recorded. He conned investors out of billions of dollars over what people think could have been a 50-year period until his arrest in 2008.
Stole: $20 billion
Punishment: 150 years in prison
Using an offshore bank, Stanford stole billions of dollars from investors across the globe. Almost 30,000 investors were given fake certificates of deposits and promised huge returns.
Stole: $7 billion
Punishment: 110 years in federal prison
A businessman from Minnesota, Petters scammed investors out of billions of dollars after they invested in his business which promised profits from reselling retail merchandise.
Stole: $3.7 billion
Punishment: 50 years in federal prison
Using his law degree to his advantage, Rothstein used his law firm to convince investors to buy into several fake legal settlements.
Stole: $1.2 billion
Punishment: 50 years in prison
The man behind 90’s boy bands ‘NSync and The Backstreet Boys stole $300 million from investors and banks, funding a business that didn’t actually exist.
Stole: $300 million
Punishment: 25 years in federal prison
Since Ponzi schemes don’t involve selling a product, nearly all versions of this deception occur in the financial world.
Most common Ponzi schemes take the form of an “investment company” or other similar business persuading you to give them your money. Again, they’ll almost always promise you significant returns in no time—and may even deliver with some consistent payments.
Still, some scammers go out of the way to create a fake business model to fool investors further. Some recent examples include:
Ponzi schemes are often confused with pyramid schemes, and though the plots are closely related, they’re not exactly the same.
Both Ponzi schemes and pyramid schemes rely on a constant flow of new investments to create “profits” for previous investors, but the major difference between the two is how those new investors are found.
A Ponzi scheme typically comes down to one mastermind, posing as a “portfolio manager” or other fraudulent position. Clients approach this person with investments and collect their money when they’re ready to cash out. Meanwhile, the person in charge finds new clients and will move all the money around his- or herself.
With a pyramid scheme, that job is outsourced to the people being scammed. Investors in a pyramid scheme are incentivized and/or required to recruit new investors to keep up the cash flow. Each person joining the scheme must pay the person who recruited them, and proceeds are shared with people higher up the chain.
Though multi-level marketing (MLM) investments are technically legal, MLM schemes are similar in structure to both Ponzi and pyramid schemes.
The major difference is that a Multi-level Marketing scheme involves selling an actual product, whereas pyramid and Ponzi schemes simply focus on moving money around. Still, an MLM scheme is modeled closely after a pyramid scheme, with investors still incentivized to find new recruits who will then, in turn, pay a portion of their profits forward.
If there’s one silver lining about how prevalent Ponzi schemes are, it’s that the plots can be more easily detected—if you know what to look for.
Some major red flags include:
Avoiding Ponzi scams, as with avoiding most unpleasant things, a good defense usually makes the best offense.
There are a few steps you can take to help stop you from getting involved in Ponzi schemes, to begin with, including:
If you think you have or are currently participating in a Ponzi scheme, don’t worry. There are still some steps you can take to protect yourself.
First and foremost, you should consult with a Ponzi scheme lawyer. Choose someone who works in your state, as laws may vary by area.
It’s important to make this step discretely. You don’t want to tip off the person running the scheme.
Your lawyer should help you understand the legal ins and outs of the situation and help create a list of paperwork and documents you’ll need to pursue a case or exit the situation.
Don't believe everything you hear. If someone promises high returns on a bitcoin investment, proceed with caution.
Scammers take advantage of PayPal's buyer protection program to scam sellers out of their money and items for sale.
Not every phone call from a government agency is legit, in fact, the majority of calls that have a "Social Security Administration" caller ID are actually from scammers.
With many people opting for CBD products as a natural alternative to prescription drugs, it's important to know what to look for in CBD oils and other cannabinoids products.
New WhatsApp scams are making the rounds in the lead-up to Father’s Day 2022—here’s what you need to know.
Delivery companies like FedEx, USPS, and UPS are being impersonated in text messages instructing recipients to visit a scam website—here's what you need to know.
Receive a text message about a USPS delivery? If it contains a link, it's a scam—don't click the link!
If you receive a call from Amazon about suspicious activity on your account, it's likely a scam, and you should hang up immediately.
This scam starts with a recorded message about an early (or unwanted) Amazon Prime renewal. To 'cancel,' you will unknowingly be transferred to a scammer impersonating 'Amazon.'
People receiving unemployment assistance are being sent fake text messages posing as EDD or Bank of America to con users into giving out their personal information.
If you own a motorcycle, you can get coverage from a regular auto insurance company or through Harley-Davidson.
Car insurance coverage is important, but it can be confusing, especially if you're new to having your own vehicle.
Buying a used car can be stressful, but knowing what questions you should ask the seller can help you feel confident in your decision.
If you're a DIY person, why not have a go at changing your oil filter by yourself? Save yourself some money and feel accomplished in the end.
Although a lot of work has been done to remove counterfeit Apple products from shelves and online stores, fake Apple watches are still easy to come by.
Find out what the overturning of Roe vs. Wade means for abortion rights in your state.
The number of people searching for the term "COVID vaccine 5G" on Google has just hit an all-time high, but there's one way to be sure that there are no microchips.
Social media platforms are possibly the most used tools in committing fraud, responsible for $770 million in losses.
The FBI is warning Americans about a new scam circulating in the country involving fraudulent QR codes in public places.
Fake Gucci, Chanel, and Louis Vuitton handbags and clothing were just some of the items found in a large shipment of counterfeit goods coming in from China.