A Ponzi scheme is a deception where people are enticed into investing money in exchange for the promise of unusually high returns within a short time, with early investors being paid off from the cash extracted from later investors. The person operating the scheme puts all of his efforts into attracting new investors, since new investors are needed to maintain an increasing inflow of cash.
The deception eventually collapses when the stream of incoming cash flows declines below the amount of outgoing cash flows. The person originating the deception typically disappears with all remaining cash shortly before the scheme would have collapsed anyways. The scheme is named after Charles Ponzi, who operated such a deception in the 1919-1920 time period, bilking more than $15 million out of investors.
A Ponzi scheme may be in operation when the following indicators are present:
- A promise of high returns
- A continuing stream of reported earnings, irrespective of market conditions
- Difficulty extracting money from the operation, especially after it has been operating for some time
- Investment strategies that are described as secret
- A lack of registration with the Securities and Exchange Commission