What Is A Ponzi Scheme?
A Ponzi Scheme is a type of financial fraud pioneered by Charles Ponzi in 1919. The idea behind a Ponzi Scheme is that investors are offered high return and low risk and are therefore encouraged to invest. However, there is no actual investment going on with the funds, the return is simply provided by more investors joining the scheme. This can continue indefinitely and investors can receive their high returns, but as soon as the Ponzi scheme fails to attract enough new investors, the original investors will lose money.
For example, if a fund running a Ponzi Scheme offers investors a 10% return for an investment of $10,000 and there are 5 initial investors, the total invested is $50,000 and the fund needs to return $5,000 to those investors. In order to do this, the fund requires an additional investor and uses their money to pay off the original 5. However, it now needs to provide that 10% return to the newest investor and must therefore find another and this goes on and on until eventually no new investors can be found.
One of the most famous Ponzi Schemes was run by Bernard Madoff who defrauded investors out of over $50 billion during the early 2000s.