What is a Ponzi Scheme?

Ponzi scheme can be explained as fraudulent operation for investment that promises high return rates to various investors from either their own money or from the money from the subsequent investors, leaving little risk to the investors. The scheme tries to generate returns for the old investors by gaining new investors.

A Ponzi Scheme essentially works as long as new investors are investing into the scheme. This in turn propels the continuous returns to the earlier or older investors. Thus, as and when, with time, the new investors stop investing in the scheme, the entire house of cards will collapse automatically. These sorts of investment plans are short-term scams that aid a company to attract or lure fresh and new investors, who invest their money and thus help with unusually consistent and abnormally high returns to the earlier investors. This scheme is often compared to the illegal pyramid schemes.

According to Investopedia, a Ponzi Scheme is named and termed after the clerk Charles Ponzi, who was blamed with notoriety for using such luring investment schemes to dupe thousands of people in New England into investing into Postage Stamp Scheme, back in the year 1919. The man immigrated to the United States from his hometown in Italy. Although, he did not invent this investment scheme, he surely made huge money with the help of this operation and thus came into the eyes of the people who later used the same technique to do the same.

However, the scheme collapses with time as the earnings are comparatively less than the payments made. Also the scheme is watched on with suspicion and thus might get interrupted by the legal authorities. The scheme is often seen as an investment boon for all its investors providing them with high returns even at the time of completion of the scheme. But in reality, such schemes only serve the initial investors or the people who started the scheme — all at the cost of innocent investors who invest towards the later part of the scheme.

A Ponzi Scheme, therefore is essentially a fraudulent operation. Throughout history, there have been several such Ponzi Schemes perpetrated by many people. One of the latest well known scams was the one run by Bernie Madoff who was then sentenced to 150 years in prison. The unveiling of this 50 million dollar scam will remain in the minds of the people of America, close as it came at the early days of the current economic recession.