Well, in short, a ponzi scheme is a scam, in which victims are coerced into investing in an entity that doesn't exist. Ponzi Scheme operators recruit unsuspecting individuals by promising that they will "get rich quick" by putting money into a promising business or exclusive investment portfolio. However, this money is never actually invested, and, instead, ends up as profit for the fraudsters or small payments for early investors, to provide the illusion of stock growth. This practice is also known as "robbing Peter to pay Paul", and self-sustains until there aren't enough new investors, or until enough of the victims ask for their money back. When the scheme eventually unravels, hedge fund managers profit off whatever money is left.
The term "ponzi scheme" was coined in 1920, after Italian-American businessman Charles Ponzi gained notoriety for his investment fraud operation, which cost his clients an estimated $20 million dollars. Ponzi's front company promised investors huge returns by purchasing cheap postal reply coupons from overseas and redeeming them for US postage stamps, which is just about the most 1920s crime ever.
Today, most people associate ponzi schemes with Bernie Madoff, the mastermind behind the largest investment fraud operation in US history. For decades, Madoff used his credentials as a well known NASDAQ chairman and Wall Street bigwig to coerce investors into his investment firm. The scheme robbed billions from wealthy individuals, as well as charitable organizations, universities and publicly-traded banks. In 2009, he was sentenced to 150 years in prison. Ponzi schemes are often conflated with pyramid schemes, as both are "get rich quick" scams fueled by fraudulent investments.
A pyramid scheme starts with one investor, who recruits others by promising them high returns. Those second investors make a payment to to the initial investor in exchange for the ability to recruit more investors who will pay them. As more subordinate investors are recruited, the pyramid grows larger and larger. But as the pyramid grows, the returns get smaller. Until eventually there are no returns, so people stop buying in and the pyramid collapses, leaving those at the bottom with the biggest losses.
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