Fraudsters thrive in times of uncertainty. They don’t even need new tricks when old ones still work like a charm. We’re talking about Ponzi schemes, notorious cons that have been cheating people out of their savings since well before the telephone, let alone the convoluted digital world we live in today.
What are Ponzi schemes, and how can you recognize one? More importantly, how do you keep from becoming caught up in one? Our in-depth guide has all the answers.
What Are Ponzi Schemes?
A Ponzi scheme is a type of investment fraud that promises unreasonably high returns without risk. It hinges on attracting new investors to pay out early adopters. The scheme owes its name to Charles Ponzi, a scam artist who orchestrated an elaborate ruse based on the shifting value of postal reply coupons.
Although not the first of its kind, the original Ponzi scheme defrauded thousands of victims, costing the modern equivalent of $230 million. While substantial, the losses pale compared to the likes of Bernie Madoff’s $18 billion scheme. Another more recent example is the downfall of FTX, the second-largest cryptocurrency exchange in 2022, which cost investors $8 billion.
How Do Ponzi Schemes Work?
At their core, Ponzi schemes prey on people’s lack of financial literacy and desire for quick gains. The investment opportunity itself doesn’t matter. Schemes have been peddling everything from bonds through shares in gold mines to up-and-coming cryptocurrencies. The thing they all have in common is a promise of returns far above market rates, often 50% or more in a year or less, when regular markets deliver much less during the profitable years.
Ponzi schemes are attractive because early adopters do see advertised returns. Word of mouth and aggressive marketing campaigns attract even more investors, allowing a small subset of them to profit. Some schemes might try to diversify, but the capital fresh investors bring is the main and most often the only revenue stream.
Unsurprisingly, all Ponzi schemes eventually run out of steam since it’s impossible to maintain the exponential investor acquisition rates required to keep the payouts flowing. Meanwhile, the organizers spend lavishly, stash the profits in offshore accounts, or try to mask their digital coins’ origin by hopping from blockchain to blockchain. Either way, investors never fully recoup their losses.
How to Recognize a Ponzi Scheme?
While Ponzi schemes grow in sophistication and adapt to the times, their core goals and tactics don’t change drastically. Consider these red flags if you’re unsure whether an enticing investment opportunity could be one:
Is it too good to be true?
Ponzi schemes rope people in with unrealistic promises. Even a cursory Google search reveals there’s no such thing as a risk-free investment. Markets fluctuate, usually coming out ahead in the long term but shifting from gains to losses and vice versa in the short term. Anyone who claims they can outperform trillion-dollar markets and the financial institutions that facilitate them is being dishonest.
Is it transparent?
Legitimate investment companies adhere to extensive legislation and a professional code of conduct. They have to register with the SEC, FINRA, or equivalent regulatory bodies. Companies and individuals involved in Ponzi schemes will try to circumvent this, claiming to be exempt.
Can you understand what you’re investing in?
Being intentionally vague or using complicated language when explaining investments is another telltale Ponzi scheme sign. This serves to make the scammers appear like experts and discourages questioning. If no one can explain how the company supposedly makes legitimate profits in layman’s terms and provide proof, chances are fleecing investors is the only thing they’re doing.
How did you learn about the opportunity?
Aggressive advertising is key to attracting as many victims as possible. Common tactics include prominent social media campaigns or using existing investors as ambassadors. Some of them may even be celebrities, which increases the appearance of credibility. Add a large dose of FOMO, and you’ve got a lure inexperienced investors will find hard to resist.
Can you cash out?
The last thing Ponzi con artists want you to do is to cash in on those high returns. Is it unnecessarily complicated to cash out? Are they offering to roll your money over instead for bigger future returns? Are there endless complications and delays when you do decide to withdraw? If so, you’re likely caught up in a Ponzi scheme.
How Not to Become a Victim
As in all things, knowledge is power when considering new investment opportunities. Doing research before handing your hard-earned cash over will protect you from committing a costly blunder.
Start by checking whether the company promoting an investment is registered with the proper authorities. Consider the industry you’ll invest in, its past performance and prospects. Compare the claims the company makes with historical averages and realistic predictions from trusted sources. When in doubt, always seek the help of an accredited and unbiased financial advisor or broker.
You’ll likely do most of your research online, which comes with unique challenges. Specifically, visiting various investment and finance-related sites will alter the ads you see while browsing. Some of these may expose you to fraudulent investments. Moreover, if you conduct such research on an unsecured network like public Wi-Fi, you may attract unwanted attention from hackers eager to steal your identity.
You’ll want to use a trustworthy VPN when conducting any online research. Doing so obscures your IP address, so advertisers can’t profile you based on your internet history. Moreover, VPNs encrypt the connection, securing information exchanges and financial transactions from prying eyes. Understanding vpn meaning is essential to fully grasp these benefits.
If you’re already a victim, stop investing immediately. Try to get as much of your money out as possible and contact the police or an attorney to start an investigation into the fraud.
Conclusion
Ponzi schemes continue to rob people of their money and peace of mind. They’re a persistent threat that takes advantage of hope and inexperience. Now that you know them for what they are, the chances you’ll fall for one are much slimmer.