A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own
money or the money paid by subsequent investors, rather than from profit earned
by the individual or organization running the operation. The Ponzi scheme
usually entices new investors by offering higher returns than other
investments, in the form of short-term returns that are either abnormally high
or unusually consistent. Perpetuation of the high returns requires an
ever-increasing flow of money from new investors to keep the scheme going.
Five
Key Elements of a Ponzi Scheme
1.
The Benefit: A promise that the investment will achieve an above normal
rate of return. The rate of return is often specified. The promised rate of
return has to be high enough to be worthwhile to the investor but not so high
as to be unbelievable.
2.
The Setup: A relatively plausible explanation of how the investment can
achieve these above normal rates of return. One often-used explanation is that
the investor is skilled and/or has some inside information. Another possible
explanation is that the investor has access to an investment opportunity not
otherwise available to the general public.
3.
Initial Credibility: The person running the scheme needs to be
believable enough to convince the initial investors to leave their money with
him.
4.
Initial Investors Paid Off: For at least a few periods the investors
need to make at least the promised rate of return - if not better.
5.
Communicated Successes: Other investors need to hear about the
payoffs, such that their numbers grow exponentially. At the very least more
money needs to be coming in than is being paid back to investors.
Steps
in the Ponzi Scheme
Ponzi Schemes are quite basic but can be
extraordinarily powerful. The steps are as follows:
1.
Convince a few investors to place money into the investment.
2.
After the specified time return the investment money to the
investors plus the specified interest rate or return.
3.
Pointing to the historical success of the investment, convince
more investors to place their money into the system. Typically the vast
majority of the earlier investors will return. Why would they not? The system
has been providing them with great benefits.
4.
Repeat steps 1 through 3 a number of times. During step 2 at one
of the cycles, break the pattern. Instead of returning the investment money and
paying the promised return, escape with the money and start a new life.
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