We can define a Ponzi scheme as a fraudulent investing scam that promises huge revenues with very little risks to investors. This kind of scheme usually gets revenues for previous investors by looking for new investors. This type of fraud is very much like a pyramid scheme because both of them are entirely based on the use of the new investors´ money to cover the preceding backers. In this kind of schemes, it is very possible that there will be enough money to go around. For this reason, it will implode at any time.
You have to be very careful with these kinds of investment frauds because they will promise you an incredible large profit without any risk, but nothing of that is true. In consequence, most of companies that have been engaged in a Ponzi scheme usually are focused on attracting new investors every time. In the very near future, this new income will be used to pay preceding clients their revenues. Ponzi schemes are commonly based on flow on new clients with the goal of providing returns to previous investors.
The exact origins of Ponzi scheme
During the 1910s, Charles Ponzi created the Ponzi scheme (the first of its kind.) In those times, the postal service developed international reply coupons that give senders the option of pre-purchasing postage and including it in their own correspondence without any problem. At that time, if you receive a coupon, you had to take it to any local post office and exchange it the postage stamps you were required to have in order to respond to the sender.
It is very important to mention that it was very common for this kind of stamps to have many prices in each country. This was partly due to the changing prices of them. Taking advantage of the circumstances, Ponzi hired agents whose objective was to purchase cheap international reply coupons in many different countries and send coupons to him. After doing so, Ponzi exchanged them for stamps that world be much more expensive that the previous coupon. Later, they would be sold with a higher price.
In those times this kinds of economic activities were no illegal. When his company grew, he was promising returns of more than 50% in 45 days. Taking into account his incredible success, many investors thought it would be a good idea to invest in this kind of scheme. Soon after, he would distribute returns and told the investors they obtained a benefit. During the twenties, Ponzi was a target in an investigation for fraud. Over time, it would be consider as a very risky practice, so be very careful.
Usually, these kinds of fraudulent investment operations need a first investment and promise high returns. You have to take into consideration that the promoter commonly takes advantage of a lack of investor knowledge. Apart from this, they uses unknown strategies and do not give any kind of information about the scheme they use in order to mislead investors. At the beginning, this promoter pays huge returns with the goal of attracting new clients and encouraging previous clients to invest more money.
At the moment new clients are starting to take part in the scheme, problems start to occur. The return that has to be paid to the first client is generated by the money of new investors. Sometimes, huge returns led clients leave their money in the Ponzi scheme, that is to say, the promoter will not be required to pay much returns to clients. He/she just has to show them how much they are earning and that is all. In consequence, investors continue to consider that this practice is a very good investment with huge returns.