Ponzi schemes are named after Charles Ponzi, an Italian swindler who, in the early 1920s, defrauded hundreds of victims with his deceptive money-making system that ran for over a year. In essence, a Ponzi scheme is a fraudulent investment scam where returns to existing investors are paid from funds contributed by new investors. The flaw lies in the fact that investors in the latter stages may never receive any returns.
The operation of a Ponzi scheme typically follows these steps:
- A promoter takes $1000 from an investor, promising to repay the initial amount plus a 10% interest at the end of a set period (e.g., 90 days).
- The promoter secures two more investors before the 90-day period elapses, using their $2000 to pay the first investor $1100. The first investor is often encouraged to reinvest the initial $1000.
- By recruiting new investors, the fraudster can fulfill the promised returns to earlier investors, urging them to reinvest and bring in more participants.
- As the scheme expands, the promoter must continuously attract new investors to sustain it and meet the promised returns.
- Ultimately, the scheme becomes unsustainable, leading to the promoter’s exposure or disappearance with the accumulated funds.
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