A Ponzi scheme is a fraudulent investment scheme that involves promising high returns to investors based on the funds collected from new investors, rather than from legitimate profits. It is named after Charles Ponzi, an Italian-born swindler who became infamous for running such a scheme in the early 20th century.
In a Ponzi scheme, the fraudster typically attracts investors by offering them unusually high and consistent returns on their investments. These returns are often much higher than what can be achieved through legitimate investment opportunities. The fraudster may claim to have a unique investment strategy or special access to lucrative markets to explain the extraordinary returns.
Initially, the scheme appears to be successful, and some early investors may even receive the promised returns. This creates an illusion of legitimacy and entices more people to invest. However, instead of generating actual profits through legitimate means, the fraudster uses the funds from new investors to pay the returns promised to existing investors. This creates the false impression that the investment is profitable.
As the scheme progresses, it becomes increasingly reliant on new investors to sustain the payouts to earlier investors. Eventually, when there are not enough new investors to sustain the scheme, it collapses. At that point, the fraudster is often unable to meet the financial obligations to investors, and the scheme unravels, causing significant financial losses for those involved.
Ponzi schemes are illegal and considered fraudulent because they operate by deceiving investors, misrepresenting the source and sustainability of the returns. They rely on a constant influx of new funds to keep the scheme going, and when that flow stops, the scheme collapses. Ponzi schemes are unsustainable in the long run and inevitably lead to financial ruin for most participants.