Ponzi Scheme

A fraudulent investment program that involves using funds raised from new investors to pay off the earlier investors

Author: Hassan Saab
Hassan Saab
Hassan Saab
Investment Banking | Corporate Finance

Prior to becoming a Founder for Curiocity, Hassan worked for Houlihan Lokey as an Investment Banking Analyst focusing on sellside and buyside M&A, restructurings, financings and strategic advisory engagements across industry groups.

Hassan holds a BS from the University of Pennsylvania in Economics.

Reviewed By: Matthew Retzloff
Matthew Retzloff
Matthew Retzloff
Investment Banking | Corporate Development

Matthew started his finance career working as an investment banking analyst for Falcon Capital Partners, a healthcare IT boutique, before moving on to work for Raymond James Financial, Inc in their specialty finance coverage group in Atlanta. Matthew then started in a role in corporate development at Babcock & Wilcox before moving to a corporate development associate role with Caesars Entertainment Corporation where he currently is. Matthew provides support to Caesars' M&A processes including evaluating inbound teasers/CIMs to identify possible acquisition targets, due diligence, constructing financial models, corporate valuation, and interacting with potential acquisition targets.

Matthew has a Bachelor of Science in Accounting and Business Administration and a Bachelor of Arts in German from University of North Carolina.

Last Updated:December 17, 2023

What Is a Ponzi Scheme?

An imitation investment scheme known as a "Ponzi scheme" entices investors with claims of huge profits and low risk. A Ponzi scheme is an unethical investment strategy in which money is taken from later participants with the goal of paying out profits to the original investors.

Ponzi schemes are unsustainable in the long run because they require a constant stream of funds to maintain. When it becomes difficult to attract new investors or when a large number of current investors choose to cash out, the program fails.

Ponzi schemes rely on a steady inflow of new investors to stay afloat because they have little to no genuine earnings. These schemes usually collapse when it becomes hard to find new investors or when many existing investors take their money out.

The Ponzi scam got its name from Charles Ponzi, a con artist who used a postage stamp speculative scheme to deceive investors in the 1920s.

Key Takeaways

  • The Ponzi scam brings in new investors by promising them a substantial payoff with little to no risk, which creates returns for previous investors.
  • The basic idea of the fraudulent investment scheme is to reimburse the initial backers with money from future investors.
  • Ponzi schemes often prioritize finding new investors as a primary focus; without them, the scheme may run out of money.
  • Regulatory scrutiny, economic downturns, or other events that obstruct the flow of new investments sometimes lead to the collapse of Ponzi schemes since they depend on the steady input of new money to survive.

Understanding Ponzi Schemes

A Ponzi scheme represents a deceptive investment strategy that entices participants with promises of substantial profits. It functions by using cash from fresh investors to settle debt from previous ones, giving the appearance of profitability.

Ponzi schemes are, however, unsustainable over the long run because they often lack sufficient legitimate profits to cover the promised returns. Usually, they make low-risk investment promises, are opaque, and eventually fail because there aren't enough new investors to maintain payouts. 

Ponzi schemes are regarded as a type of fraud and are forbidden. They hurt those who join the program too late and those who might lose all of their money if the scam falls apart for some reason.

Investors should exercise caution, perform due investigation, and exercise skepticism when considering any investment that promises unusually high returns or lacks transparency.

Ponzi Scheme Red Flags

Because Ponzi schemes are frequently made to seem legitimate, spotting one can be difficult. But there are a few warning signals and cautionary signs you may look out for to help spot a potential Ponzi scheme:

  1. High returns with little or no risk: Every investment entails some level of risk, and more risk is often present in investments with larger expected returns. Any "guaranteed" investment opportunity should be viewed with extreme caution.
  2. Overly consistent returns: Ponzi schemes sometimes include investments not registered with state or federal regulators or the SEC. Registration is crucial to give investors access to information about the company's management, goods, services, and finances.
  3. Unlicensed sellers: Investment professionals and firms are required to be licensed or registered under federal and state securities regulations. Most Ponzi schemes involve unregistered businesses or unlicensed persons.
  4. Secretive, complex strategies: If you are unsure about an investment or are unable to obtain all the necessary facts, steer clear of it.
  5. Issues with paperwork: Errors in account statements could indicate that money is not being invested as promised.
  6. Difficulty receiving payments: Be cautious if you encounter difficulties receiving payments or face challenges with payouts. Ponzi scheme operators might attempt to dissuade participants from leaving by promising even greater rewards for staying.

Bernie Madoff Scheme

The most famous Ponzi Scheme was Bernie Madoff’s scheme. Bernie Madoff was an American fraudster and financier publicly acknowledged as the brains behind the largest $64.8 billion Ponzi scheme in history.

He previously served as the Nasdaq stock exchange's chairman. The Ponzi scheme was concentrated in the asset management industry, which was one of the two primary divisions of Madoff's company.

In 2008, Madoff pretended to be a reputable financier and enticed investors with the promise of consistent, high profits that ranged from 10% to 12% annually. However, he didn't reveal anything about his investment plan or methods to get these gains.

The plan collapsed as investors started withdrawing their money during the economic slump, which ultimately revealed that Madoff had been operating a huge Ponzi scheme.

He was detained, found guilty of several offenses, and sentenced to 150 years. The scheme cheated investors out of billions of dollars, including common people, charities, famous people, and financial organizations.

Example — Lebanon Ponzi Scheme

In September 2021, the government and banking institutions were the targets of significant protests as Lebanon struggled with a serious financial and economic crisis. 

A depreciated currency, extreme economic hardship for the Lebanese people, and hyperinflation were the main characteristics of the crisis. Lebanon's governmental and financial institutions have been accused of corruption and financial mismanagement.

The narrative of Lebanon's financial breakdown since 2019 reveals a thwarted plan to rebuild a country once dubbed the "Switzerland of the Middle East." Mismanagement and corruption by a sectarian elite, freely borrowing, played a role.

After being destroyed by the Civil War, downtown Beirut was rebuilt with buildings designed by renowned architects and upscale malls stocked with high-end retailers that accepted dollars as payment.

After the civil war, Lebanon's finances were balanced by revenue from tourism, international aid, profits from its financial sector, and the generosity of the Gulf Arab states, which funded the country by increasing central bank reserves.

But Lebanon's debt pile, one of the heaviest loads in the world at 150% of national production, had little else to show for it. The only stable export from Lebanon is its human capital because its electrical plants cannot keep the lights on.

According to some economists, Lebanon's financial system resembles a nationally supervised Ponzi scheme in which fresh loans are made to settle debts owed to previous borrowers. It functions up till new funds run out.

Transfers fell short of imports of everything from luxury autos to staple foods, sending the budget deficit skyrocketing and the balance of payments farther into the red.

In 2016, banks started providing astounding interest rates for fresh deposits of dollars, a recognized currency in the dollarized economy, and much more astounding rates for deposits of Lebanese pounds.

Given that the Lebanese pound had been freely convertible at banks or by cashiers at supermarkets and had been linked to the dollar at 1,500 for more than 20 years.

How Did Banks Offer High Returns?

The mechanism through which banks in Lebanon offered high returns is intricately linked to the influx of dollars, resulting in an increase in foreign reserves. However, the corresponding rise in liabilities remains unclear and is currently debated.

According to some estimates, the central bank's assets are more than offset by what it owes, suggesting that it may hold significant losses.

In the meantime, the price of servicing Lebanon's debt rose sharply to a third or higher of budgetary expenditures. This escalation in debt servicing expenses further exacerbated the financial challenges faced by the nation.

The Collapse

Before the 2018 election, politicians lavished on a public sector wage increase despite the state's need to cut spending. Additionally, foreign donors withheld billions of dollars they had promised due to the government's failure to implement reforms.

The last cause for dissatisfaction was a proposal to charge for WhatsApp calls in October 2019. With a large diaspora and a low tax system that benefits the wealthy, it was terrible to charge for the means by which many Lebanese maintained contact with their family members.

Massive demonstrations broke out against a political elite, many of whom were aging warlords who prospered while others struggled, pushed by dissatisfied youth wanting radical change.

Foreign exchange inflows dried up, especially US Dollars. Banks had to close their doors because they ran out of money to pay the waiting outside depositors.

The value of the money plummeted, falling from $1,500 to a street cost of 89,500 LBP (Latest Price).

An explosion at the port of Beirut on August 4 that killed nearly 190 people and caused billions of dollars worth of damage made matters worse.

How to Avoid Ponzi Schemes?

Exercise vigilance and adhere to certain important rules to prevent being a victim of Ponzi schemes and fraudulent investments. Here are some tips:

  1. Use only trusted advisors: This includes investigating the person's credentials, prior investment experience, and certification. The relationship with the organizations allows people who have earned certifications from the Financial Planning Association and the Certified Financial Planner Board of Standards.
  2. Conduct thorough research: Any investment proposal should be thoroughly researched, including the people or businesses advertising it, like examining a company, its operations, and its paperwork by the SEC (Securities Exchange Commission). Find reliable information sources and check their credentials.
  3. Ask questions: Be wary of investing possibilities that guarantee returns that seem exceptionally high. Ask for further information about the investment's profit-generating mechanism.
  4. Beware of pressure: Potential investors are frequently under pressure from con artists to act quickly. Take your time considering it, and seek the help of a financial counselor if necessary.
  5. Checking registration: Ensure the investment is registered with the appropriate regulatory authorities and any individuals or organizations involved. Based on the country and the sort of investment, this varies.
  6. Understanding the investment: Ensure you completely understand the operation of the investment and the source of returns. Do not make investments with unclear or overly complicated justifications.
  7. Monitoring investments: Review your investment statements frequently and keep an eye out for any inconsistencies or abnormalities. Investigate any issues right away.
  8. Reporting suspicions: Report any suspected Ponzi scheme or investment fraud to the appropriate regulatory bodies and police enforcement. Your actions might keep others from suffering the same fate.


Ponzi schemes are dishonest financial schemes that entice investors with guaranteed returns. The plan works by paying returns to earlier investors with money from younger investors, giving the appearance of profitability.

Avoiding Ponzi schemes involves several actions, including researching investment opportunities in-depth, asking insightful questions, avoiding high-pressure situations, and verifying registrations with regulatory bodies.

Also, watch warning signs like lack of transparency, seek independent advice, keep written records, monitor investments, and report suspected Ponzi schemes to authorities.

Investors and financial advisors expect to be held to fiduciary duty when they receive money from their clients. Regretfully, money can be fraudulently mismanaged through the employment of Ponzi schemes.

Because they use one investor's money to pay another, ponzi scams aren't legitimate investment plans.

Maintaining a healthy level of skepticism is paramount to fortifying financial security. By implementing these safeguards, investors can shield themselves from falling victim to Ponzi schemes that hinge on trust and grand promises.

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Researched and authored by Ray Bassil | LinkedIn

Reviewed and edited by Parul GuptaLinkedIn

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