A Ponzi Scheme is a fraudulent investment designed to separate the investors from their money and it was named after Charles Ponzi who had used this technique in 1920.
The scheme is designed to convince individuals or the public to put their money into fraudulent investments and once the fraud artist feel that enough money has been generated he will disappear and take all the money with him. Usually they pay the returns to investors by subsequent investors or by using their own money.
Ponzi Schemes usually attract new investors by offering high short-term returns that usually cannot be found on other similar legit programs and therefore these schemes produce a high flow of money very fast from new investors eager to get in on making money fast. A variety of investments or strategies looking legitimate had become the basis of Ponzi schemes.
High returns will encourage the investors to leave their funds in the scheme for statements are usually sent out showing investors the huge amounts that they have earned and how they can earn even more by leaving their profits to generate even more. Withdrawals are minimized by offering new plans and options to investors promising even more returns. These methods generate the impression that the scheme is a fund with high returns on investments.
Ponzi schemes usually do not have a problem paying out the funds in the early stages of the program and requests are usually processed promptly without any problems to create the illusion that the program is legit.
Four steps on how Ponzi Schemes work
Prove Credibility – The company or Individual that runs the scheme will need to prove to new investors that they are is trustworthy and convince people to invest money into the program.
Initial Payouts – For a certain period of time the investor will indeed come through on the promises made and pay out the returns to members in order to suck in more individuals.
Spreading of word – Normally these programs will offer their members even greater benefits for promoting or referrals in order to spread the word and build a so called huge community by convincing more individuals to invest money into the system, after all a huge program with tons of members have more credibility than a small one with only a few.
Rinse and Repeat – Promoters will repeat the steps above as many times as success for them allow it, as soon as warning signs come up they will close down the scheme and take the money left (usually a massive amount).
Why does a Ponzi scheme fall apart?
Some Ponzi schemes will collapse due to being stopped by the authorities but these would be the main reasons:
- These schemes require a regular but also consistent flow of money from new or existing investor in order to continue and Ponzi schemes usually collapse when it become difficult for them to recruit new investors or when a large number of their current investors demand for cash payouts on big amounts.
- The owner(s) of the schemes will take all the money within the program and vanish without any payouts to the investors.
- External market factors like a decline within the economy may force a lot of investors to demand a withdrawal of their money, resulting in the promoter ending the scheme.
- Warning signals from outside sources also cause promoters of ponzi schemes to end it, due to the panic created within investors and causing them to withdraw all of their money.
The warning signs of a Ponzi scheme
Unregistered Investments - Registration provide investors with key information about the company’s products, finances and management. Ponzi schemes involve funds or investments that haven’t been registered with state regulators or with the SEC.
High returns with little or no risk – Almost every investment have some degree of risk to it and obviously higher returns will involve more risk. Be suspicious of programs, companies or individuals that promote “guaranteed investment” opportunities, regardless of the general market conditions.
Complex strategies within the program- Be cautious with investment plans, which does not allow you to get complete information and statistics. Also, avoid programs with complex methods of earning that you don’t understand.
Difficulty in receiving payments – Ponzi promoters have the ability to convince their investors to keep their funds within the system in order to gain even bigger amounts of money. Be suspicious if you struggle to cash out on your investments.
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