What is a Ponzi scheme? What are the methods of fraud?

Many people feel deep anger towards Ponzi schemes, which are a hallmark of financial fraud. They exploit human greed, allowing dreams of wealth accumulation while siphoning off the hard-earned money of “investors.” Most financial fraud can be said to be new schemes derived or mutated from this Ponzi scheme. While many people may have heard this term, they might not be well-acquainted with its origins or methods. This time, let's explain Ponzi schemes, present some representative cases, and consider ways to prevent victimization.

What is a Ponzi Scheme? A Retrospective on Its History

The term “Ponzi scheme” derives from the Italian con artist Charles Ponzi. This scam attracts ordinary people, who lack the ability to discern the truth while harboring dreams of becoming wealthy overnight, by introducing investment opportunities that promise low risk and high returns. The scheme does not generate profits from actual investments but pays current dividends by continuously gathering new investors or persuading existing participants to contribute more funds. When the inflow of new funds stops, the scheme collapses, and the con artist makes off with all or most of the victims' money.

Origin of Ponzi Scheme

In 1903, an Italian named Charles Ponzi illegally immigrated to America. He experienced various jobs such as a painter and laborer, and served time for forgery in Canada and for human trafficking in Atlanta, America. Captivated by the American dream of success, he realized that the quickest way to make money was through finance. In 1919, against the backdrop of a chaotic world economy immediately after World War I, Ponzi took advantage of this situation, claiming that by buying European postal exchange and reselling it in America, profits could be made. He devised a complex and high-yield investment scheme and marketed it to the general public. In just about a year, around 40,000 residents of Boston participated in Ponzi's profit scheme. Many of them were poor individuals dreaming of a windfall, investing an average of a few hundred dollars, but they were people with little knowledge of finance.

In fact, anyone with even a little financial knowledge should have easily noticed that there were problems with this plan. At the time, a financial newspaper pointed out that Ponzi's investment was a scam and that such methods would never be profitable. However, Ponzi prepared a big bait to entice people while publishing rebuttal articles in the newspaper. He advertised that his plan could yield a 50% return in 45 days. As the first “investors” began to reap the sweet benefits, subsequent “investors” also started to blindly participate in large numbers. Finally, in August 1920, Ponzi's scheme collapsed, and he was sentenced to five years in prison. Since then, the term “Ponzi scheme” has become a technical term in the financial fraud industry, referring to a method where the money of later “investors” is used to pay dividends to earlier “investors,” continuing this cycle until collapse.

Introduction to Ponzi Schemes

With the rapid development of the economy and the Internet, various forms of Ponzi schemes are emerging one after another.

Maidfu Incident

The Madoff case is the most famous and longest-running typical example of a Ponzi scheme. This fraud lasted for over 20 years and ultimately came to light during the global financial crisis of 2008, when a wave of withdrawal requests of about $7 billion from investors flooded in due to a market downturn.

The Madoff Ponzi scheme is a fraud orchestrated by Bernard L. Madoff, a prominent financial broker and former chairman of NASDAQ, and is the largest fraud in American history. He infiltrated elite Jewish clubs, utilizing friends, family, and business partners to massively expand his “downline,” successfully drawing $17.5 billion in investments into a cleverly crafted Ponzi scheme. He promised “investors” a stable high return of 10% annually and boasted that they could easily make profits in both rising and falling markets. However, what the clients did not know was that the attractive investment returns were based on their own and other clients' principal, and if someone demanded a return of principal, the fraud would be exposed. Ultimately, in 2009, Madoff was sentenced to 150 years in prison for fraud. The total amount of this fraud is estimated to be $64.8 billion.

PlusToken cryptocurrency scam

The PlusToken wallet is referred to as the third largest Ponzi scheme in history on the internet. According to a report by the blockchain analysis team Chainalysis, a group of scammers impersonating PlusToken has defrauded approximately $2 billion worth of cryptocurrency investments outside of China, of which $185 million has already been sold.

In June 2019, the PlusToken wallet fell into an unrecoverable state, exposing its Ponzi scheme. This was an application launched under the banner of blockchain technology, promising users investment returns of 6% to 18% per month, claiming that these returns were generated through arbitrage in cryptocurrency trading. However, the PlusToken wallet was a multi-level marketing organization disguised with the noble concept of “blockchain.” During its operational period of over a year, it deceived many “investors” who had insufficient understanding of “blockchain,” and when the PlusToken wallet became unable to process withdrawals and customer support was halted, the investors who fell victim to the scam realized that their money had been completely lost.

How to Avoid Ponzi Schemes?

Ponzi schemes always try to deceive the public with a glamorous appearance, but before choosing an investment plan, you can evaluate it in several ways to avoid losses.

1. Be skeptical of low risk, high return Almost all investments carry risks, and there is no investment that guarantees a 100% profit. If an investment promises a continuous profit of 1% daily or 30% monthly to its customers, it is likely a Ponzi scheme. It is clearly against the principles of investing to not explain the risks to investors despite such high investment returns.

2. There is no such thing as a zero-risk investment that is guaranteed to be profitable For example, MaidF emphasized that it guarantees customers an annual return rate of about 10% and that “investments will always win and there will absolutely be no losses.” However, no investment can escape the influence of economic fluctuations, and it is impossible to guarantee 100% continuous profits or maintain the same return rate.

3. A certain level of understanding of investment products and strategies is necessary Fraudulent projects often cloak themselves in a mysterious appearance, deliberately making themselves appear obscure. They design their project offerings and investment strategies to be extremely complex and difficult to understand, but in reality, the projects they vigorously promote lack any real products or business backing.

4. Understand the project's status thoroughly Typically, if investors seek information from project managers and do not receive positive responses, and if they make excuses for various reasons, caution is necessary. This very likely indicates that they are fraudsters.

5. Utilize the Internet to research relevant information Ponzi schemes typically involve projects or investments that are not legally registered. Checking the registration status and registered capital of the project company on the business system's website, and inquiring in a timely manner about the reasons if the investment is unregistered, can help determine the authenticity of the project.

6. Difficulty of Fund Recovery This is one of the major characteristics of a Ponzi scheme, which establishes various obstacles to hinder investors from withdrawing their funds. For example, it may raise withdrawal fees or arbitrarily change withdrawal rules.

7. Identify the investment model Ponzi schemes prefer “pyramid” type investment models. We often encounter enthusiastic individuals who act as recruiters. They try to earn high commissions by pulling in underlings or introducing people. If those around you encourage participation in a project in this manner, you need to be cautious.

8. Consult an expert If general investors cannot accurately assess a project, they can seek advice from specialized consulting firms and make decisions after listening to expert opinions.

9. Understand the background of the project Before investing, conduct thorough research and fully understand the project's initiators and background to avoid pitfalls. The initiators of Ponzi schemes typically carry an aura of “genius” and portray themselves as god-like figures. For example, Sergey Mavrodi, the founder of MMM, presented himself as a “heroic” figure and deceived the masses.

10. “Money does not fall from the sky” Fraudsters exploit precisely this point of “human greed” to convince victims by painting a big bait of enormous returns for speculators. Therefore, it is crucial to keep a cool head when investing, suppress the greed within your heart, and always remind yourself to stick to your bottom line.

Summary

Ponzi schemes have continued to be packaged in various forms by speculators since their inception, but their essence remains unchanged. They share common characteristics of low risk and high returns, breaking down the eastern wall while repairing the western wall. Scammers attract investors who lack basic financial knowledge or are entirely ignorant by emphasizing the risk factors of investment without highlighting them, offering relatively high investment returns. It is essential to always remember the fundamental investment rule that “risk and return are proportional” and to maintain a sense of vigilance.

Disclaimer: The content of this article reflects the author's personal views and does not represent the official stance of Gate, nor should it be treated as investment advice. The content of the article is for reference only, and readers should not use this article as the basis for their investments. Gate assumes no responsibility for any results derived from trading based on this article. Additionally, Gate cannot guarantee the accuracy of the content of this article. Before making investment decisions, please consult with an independent financial advisor and ensure that you understand the risks involved.

_Contract for Difference (CFD) trading is a leveraged product and can result in the loss of all your invested capital. These