Ponzi Scheme Definition
A Ponzi Scheme is a fraudulent investing setup that promises high returns with little risk to investors. The scam operates by using the invested funds of newer investors to pay off the promised returns to the older investors, thereby creating the facade of legitimate business operations. The system eventually falls apart when the inflow of new investors or their funds slacken, rendering the scheme incapable of paying out to the older or existing investors.
Ponzi Scheme Key Points
- Ponzi schemes promise high returns with minimal risk.
- They are unsustainable due to their dependence on the constant inflow of new investor funds.
- Ponzi schemes inevitably collapse when new investments stop or slow down significantly.
- The scheme is illegal and punishable by law.
What is Ponzi Scheme?
The term Ponzi Scheme is widely used in the financial world to describe a type of investment fraud, named after Charles Ponzi who created such a scheme in the 1920s. The basic premise of this scam involves promising investors sky-high returns on their investments with little risk.
How Does a Ponzi Scheme Work?
A Ponzi scheme works by successfully luring a few investors and delivering high returns as promised. These returns, however, are not the result of any genuine profit-earning activity; instead, they are paid out of the principal amounts invested by new entrants to the scheme. This fraudulent setup leads to the requirement of a continuous influx of new investors to keep the scheme running.
When is a Ponzi Scheme Detected?
As long as there is a steady stream of new investors, a Ponzi scheme can continue to operate. However, when the inflow of new money slows down, the fraudsters are unable to meet the promised payments to older investors. This is typically when a Ponzi scheme gets detected – when it fails to keep up with its obligations towards the participants.
Why is a Ponzi Scheme Considered a Scam?
A Ponzi scheme is considered a scam as it invariably results in financial loss for all the participants, except perhaps the initial investors, that too, if they withdraw in time. The investments made by the newer recruits are siphoned off to pay the returns to the older investors, leaving most participants high and dry when the scheme collapses.
How are Ponzi Schemes Related to Crypto and Blockchain?
In the realm of cryptocurrencies and blockchain, Ponzi schemes manifest themselves as initial coin offerings (ICOs) or cryptocurrency investment platforms promising unrealistic returns. Because the crypto space is still relatively new and unregulated, it has become a fertile breeding ground for such frauds. Investors should practice due diligence and stay vigilant to avoid falling prey to such schemes.
