What is a Ponzi Scheme
A Ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to investors.
The Ponzi scheme generates returns for older investors by acquiring new investors.
This is similar to a pyramid scheme in that both are based on using new funds to pay the earlier backers. For both Ponzi schemes and pyramid schemes, eventually there isnt enough money to go around, and the schemes unravel.
BREAKING DOWN Ponzi Scheme
A Ponzi scheme is an investment fraud where clients are promised a large profit at little to no risk.
Companies that engage in a Ponzi scheme focus all of their energy into attracting new clients to make investments. This new income is used to pay original investors their returns, marked as a profit from a legitimate transaction. Ponzi schemes rely on a constant flow of new investments to continue to provide returns to older investors. When this flow runs out, the scheme falls apart.
Ponzi Scheme: Origins
The first notorious Ponzi scheme was orchestrated by a man named Charles Ponzi in 1919. The postal service, at that time, had developed international reply coupons that allowed a sender to pre-purchase postage and include it in their correspondence. The receiver would take the coupon to a local post office and exchange it for the priority airmail postage stamps needed to send a reply. With the constant fluctuation of postage prices, it was common for stamps to be more expensive in one country than another.
Ponzi hired agents to purchase cheap international reply coupons in other countries and send them to him. He would then exchange those coupons for stamps that were more expensive than the coupon was originally purchased for. The stamps were then sold as a profit.
This type of exchange is known as an arbitrage, which is not an illegal practice....