A Ponzi scheme is a fraudulent investing scam that promises investors high return rates and low risk. Ponzi schemes work by generating “returns” for older investors by acquiring new investors. The funds from new investors’ are used to pay earlier backers. Ponzi schemes typically unravel when there is not enough money from new investors to support the various levels of prior investors.
Understanding Ponzi Scheme Hierarchies
There are many levels of a Ponzi scheme, and they all start with an originator. People or companies that start a Ponzi scheme focus their energy on attracting new clients to make investments. The income from new investors is marked as a profit from a legitimate transaction and used to pay original investors their “returns”. The legitimate transaction that investors believe happened never happened.
In order for a Ponzi scheme to continue, it relies on a constant flow of new investments. When this cash flow runs out, the scheme typically falls apart. In some cases, such as the famous Madoff case, Ponzi schemes can operate for many years with large sums of money before they bottom out.
Ponzi Schemes vs. Pyramid Schemes
The infographic shows how a Ponzi scheme works, breaking down the various levels of a Ponzi scheme. It is often a pyramid-like structure. Unlike a pyramid scheme, investors in a Ponzi scheme believe they are investing in an actual security and unaware that new investors are the source of the ‘returns’ received.
In a pyramid scheme, though operators typically conceal the true nature of the operation, investors understand that recruiting new investors is part of their responsibility and are a crucial source of profit for existing members.
Have You Invested in A Ponzi Scheme?
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