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What is a Ponzi Scheme?

What is a Ponzi Scheme?

A Ponzi scheme is a scandal where new investment money is used to create the illusion of returns. A Ponzi scheme (named after Charles Ponzi, who in the early 1900’s was the first to effectively implement such a scheme) is essentially a confidence trick.

As an example, suppose 10 people each give someone $100 to invest, with the promise of a 10% return (in addition to the $100 principal) in a year. During the course of that year, 20 more people invest $100 each as well (for a total of $2,000 from the second group).

Since the profits of the individual or company running the Ponzi Scheme were nowhere near the amount required to reimburse the initial investors (they are owed 10 x $100 plus 10% return = $1,100), the money from the second set of investors will be used to pay back the first, and so on and so forth.

Eventually, of course, such a scheme will usually collapse on its own (people start asking for their money back, and lo and behold, the money has long been given away to others), or be discovered by authorities.

The most famous (and biggest to date) example was the Ponzi Scheme run by Bernard Madoff. Estimates of losses incurred by Madoff’s scheme reach upwards of $20 billion, and many of his victims were left completely broke.

It’s not a surprise that Madoff is serving 150 years in prison, but for most, justice will never be served since the money is simply gone.

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Keywords: market scandals, ponzi schemes, investing, money manager, Bernie Madoff,
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