What is a Ponzi Scheme?

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on January 11, 2021

Who Was Charles Ponzi?

A Ponzi scheme (or a “Ponzi scam” ) is an investment scam in which early investors are paid returns from funds contributed by later investors, although it has taken on a broader definition in recent years. 

A Ponzi scheme often conducts no actual business while the orchestrator pockets a cut of the money. 

The term originated with Charles Ponzi, who orchestrated the first of this type of scam in 1920. 

What is a Ponzi Scheme?

Ponzi schemes typically lure in investors by promising high returns with little to no risk. 

Because initial investors often see high returns at first, early Ponzi schemes often gain investor interest and confidence. 

Ponzi schemes eventually unravel when the stream of new investor capital slows down enough that investors can’t be paid anymore.

Ponzi schemes commonly share the following characteristics:

  • A “guarantee”of high return with no risk
  • The returns are consistent regardless of market conditions
  • Investments are not registered with the SEC
  • “Secret”or undisclosed investment strategies which are “too complicated”to explain
  • Official documentation is hidden from investors
  • Clients have a difficult time withdrawing their funds

Ponzi Scheme vs Pyramid Scheme

A Ponzi scheme is a type of pyramid scheme. 

All pyramid schemes require new recruits to provide funding, but with a Ponzi scheme, only the orchestrator knows about the scheme. 

Those in a pyramid scheme recruit knowing it will benefit them, whereas those in a Ponzi scheme may legitimately recommend the opportunity after receiving high returns.

The Bernie Madoff scandal was an orchestration of the largest Ponzi scheme which took almost 20 years for the scheme to be revealed, and defrauded investors more than $15 billion. 

Ponzi Scheme FAQs

A Ponzi scheme (or a “Ponzi scam”) is an investment scam in which early investors are paid returns from funds contributed by later investors, although it has taken on a broader definition in recent years.
A Ponzi scheme often conducts no actual business while the orchestrator pockets a cut of the money.
Ponzi schemes typically lure in investors by promising high returns with little to no risk.
Ponzi schemes eventually unravel when the stream of new investor capital slows down enough that investors can’t be paid anymore.