We define a Ponzi scheme as a fraudulent investing scam promising high rates of return with little risk to investors. These schemes rely on a constant flow of new investments to continue to provide returns to older investors.
The Ponzi scheme is named after a swindler named Charles Ponzi, who orchestrated the first one throughout the U.S. and Canada in the early 20th century. It all started when Ponzi hatched his “GET RICH QUICK” Scheme. The gimmick, something called the international reply coupons, was a way to prepay foreign postage of mail. Because of the US’s currency exchange quirk, Ponzi’s coupon bought at a low price overseas could be cashed in for a higher amount in the United States. He told his investors that he could double their money in just three months -kind of like a reverse payday loan and it worked, at least at first.
Investors began to get back their returns as promised, and they were so jazzed about it that they reinvested their money immediately back into his business. Money was pouring in, at least a million dollars per week but then a newspaper’s investigation revealed that there weren’t enough coupons in the world to support Ponzi’s scheme, his fraud was exposed.
Turns out, he hadn’t been investing in the coupons at all and his crazy returns weren’t the result of shrewd trading. In fact, Ponzi was simply using money from new investors to pay out “profit” to old investors. Because so many people were reinvesting, he was able to keep the scheme going for a long time. All in all, the estimated losses from Ponzi’s scheme totalled $32 million, and he went to prison. And though he is long dead, his notoriety gave birth to the term ‘Ponzi scheme’.