What is a Ponzi scheme?

December 28, 2008 – 9:21 pm – No Comment

Named after Charles K. Ponzi, Ponzi schemes have had a very prominent place in the headlines in the last few weeks thanks to the Bernard Madoff scheme. A Ponzi scheme is defined as an investment swindle in which high profits are promised from fictitious sources and early investors are paid off with funds raised from later ones. (answers.com)

So what’s the difference between a Ponzi scheme and a Pyramid scheme? From Wikipedia:

A multilevel pyramid scheme is a form of fraud similar in some ways to a Ponzi scheme, relying as it does on a disbelief in financial reality, including the hope of an extremely high rate of return. However, several characteristics distinguish these schemes from Ponzi schemes:

* In a Ponzi scheme, the schemer acts as a “hub” for the victims, interacting with all of them directly. In a multilevel scheme, those who recruit additional participants benefit directly (in fact, failure to recruit typically means no investment return).
* A Ponzi scheme claims to rely on some esoteric investment approach, insider connections, etc., and often attracts well-to-do investors; multilevel schemes explicitly claim that new money will be the source of payout for the initial investments.
* A multilevel scheme is bound to collapse a lot faster, due to the necessity of exponential increases in participant