How does a Ponzi Scheme Work- How to start a Ponzi Scheme.

How does a Ponzi Scheme Work- How to start a Ponzi Scheme.

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I thought about my first major business idea Back in 2018. It seemed perfect. This was the idea that would make me rich. It would put me on the map. It turns out that my idea was nothing but a Ponzi Scheme.

I’m glad I didn’t take any action on the idea. Otherwise I’d be in prison by now. A lot of people have confusion between multi level marketing or MLM and Ponzi Schemes. They think that this is the same thing, but it’s not.

In this blog I’ll teach you what a Ponzi Scheme is, how it differs from a Pyramid scheme and how you can start one. This is like a 2 part series. In the next part we’ll talk about the greatest Ponzi scheme ever pulled off. 

So, what exactly is a Ponzi Scheme?

A Ponzi scheme is a fraudulent business or investment activity promising exceptionally high returns with little to no risk. That’s not the best part, the best part is that, there is no “Investing” in this investment opportunity. 

Let me explain.

Let’s talk more about my business idea. I was a 15 year old kid interested in the stock market. So my plan was to gather a bunch of investors and give them a “guaranteed” 15% annual return. How? 

If 10 people invested in my fund and each person invests 100,000 dollars, I’d keep aside 15% of their money to show it as “profit” and invest the rest. If I made any profit on the 85% of the money, I’d keep it and if someone asks for their money back, I’d just pay him someone else’s share with profit.

And if things went south, what I’d do is attract more investors with the same incentives and pay them with someone else’s money.

Back then I was naïve and I thought that I could pull this off. The only problem with it is that this is super illegal. So illegal that even white people go to jail for it.

An Example.

Let’s say that I start a Ponzi Scheme. In the first year I attract only 1 customer and he invests 10,000 bucks. I guarantee him a 10% increment. So, in the first year I just keep the money like that and by the end of the year I give him his 1000 bucks as the “return”. 

This attracts another investor. He invests 50,000. So this time I keep his 50,000 in the bank but I wipe out the first guy’s entire investment on my own luxuries. And give them the return they think they’re making.

In the third year I get another investor, this time I wipe out the 2nd guys investment on my personal pleasures. So these people think that their investment is worth 167k while in reality its worth only 107k.

That’s the basic idea.

Year 1 Year 2 Year 3 Year 4 Year 5
Person A 10,000 11,000 12,100 13,310 (OUT)
Person B 50,000 55,000 60,500 66,550
Person C 100,000 110,000 121,000
Perceived Value 10,000 61,000 167,100 157,190 187,550
Actual Value 10,000 50,000 107,100 -2,810

These people think that they’re making a good return while in reality I’m just paying them somebody else’s money. I’m robbing Peter to pay Paul.

How to Identify a Ponzi Scheme?

There are a few common aspects in almost all Ponzi schemes all around the world.

  1. Exceptionally high returns. A return of 25% with very low risk sounds too good to be true. It probably is. Ponzi schemes usually attract naïve investors.
  2. Very low risk. This is like a continuation to the first point. You’re promised a very high return with very little risk. The law of the market says that with high rewards comes high risk.
  3. Very complicated methods. If you ask the perpetuator about the strategy you’ll probably hear some buzz words like Arbitrage between bid/ask spreads and AI used systems to find inefficiencies in the market. As long as you’re getting a good return, you don’t question it.
  4. Not registered. These funds aren’t registered. You wont find much or anything at all about these funds on the internet.
  5. Difficulty to exit. The whole model of a Ponzi scheme is to keep investors invested for a long time and make it difficult for them to remove money or exit.

The thing that separates a Ponzi scheme from a pyramid scheme is that in a Ponzi scheme people are paid high returns from other people’s money. Almost no investing is done. In a pyramid scheme people at the top aren’t paid through sales, rather they’re paid by recruitment of other people. A pyramid scheme grows exponentially while a Ponzi scheme tumbles much slower.

But eventually all schemes end. Unless you’re the government who can print infinite money.

How to pull off a Ponzi Scheme.

  1. Be charming and trustworthy. If you look at master psychopaths, they’re usually very charming. They have a certain way with words and you can’t help but feel nice and valued around them.
  2. Build credibility. The biggest Ponzi scheme perpetuator was the Chairman of NASDAQ, he had certain credibility to him. That’s how you attract people.
  3. Advertise using Celebs. You might have seen certain celebs or influencers promote certain pyramid schemes. Its because it works. When a celeb promotes something, people feel safe. And people NEED to feel safe giving you their money.
  4. Don’t promise unrealistic returns. Whenever I see an unrealistic return, say something like 25%, I just assume that it’s a scam. Even a 12% guaranteed return seems too unrealistic. Something like 9-10% seems reasonable.
  5. Keep enough money in cash. Don’t spend all the initial capital on useless stuff. The first year must be the most cautious one. Keep enough cash ready that you wont have a problem if a fellow investor exits.
  6. Forge documents and investments. Bernie Madoff forged documents. He managed to run a Ponzi scheme for 17 years! He would send fake reports about the client’s portfolios when in return he never invested anywhere.
  7. Be ready to fall. A Ponzi scheme cannot run forever, unless you’re the govt with a money printer. Every scheme falls. Be ready to fall.

The Fall.

There are a few reasons why Ponzi schemes don’t work in the long run. When you promise steady returns, and actually deliver them, all the eyes are on you.

If you make 25% in a bull market, people might not question you. But if you make 25% in a bear market, people will get a bit suspicious.

When the returns are too perfect, too steady, people catch it. But that’s not the biggest problem.

A Ponzi scheme falls for two main reasons.

  1. When a lot of existing investors want out. This usually happens when the market tanks significantly. When a lot of people want to exit, you should have enough money to pay all off them. If you don’t, you’ll get caught. One thing you can do in such situation is raise a lot of outside money. Attract a lot of new investors and pay their capital to existing clients.
  2. When you cant find new investors. Your existing clients want out usually when the market collapses, when the economy suffers. And that’s a terrible time to raise money. New investors don’t wanna invest in such times and you fail to attract new capital.

And your scheme collapses and you go to prison for 150 years at the age of 71. That’s right. The guy who pulled off the biggest Ponzi scheme ever got 150 years in jail. He’s still in prison.

And that’s why starting a Ponzi scheme is a terrible idea.

When you do something illegal like insider trading, your chances of getting caught for that are pretty thin. Instead they get you for perjury.

But a Ponzi scheme ALWAYS collapses. It cannot last forever. One bear market and you’re done. That’s why starting a Ponzi scheme is a bad idea, plus it’s illegal. The rise of security in the financial markets and more educated investors also make it tough to start such a scheme.

-Vikrant C.


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