A Ponzi scheme is an investment scheme that is geared toward providing returns to early investors in the opportunity that are taken from funds collected from later investors. Often appearing legitimate on the front end, the Ponzi scheme usually collapses as the ability to continue obtaining paying investors begins to fail. In some instances, the Ponzi scheme is undertaken with a sincere effort to eventually turn a profit and be able to honor all commitments made to investors. At other times, the scheme is intended to generate wealth for the instigator of the scheme with little or no effort to actually generate profits.
While the concept of a Ponzi scheme goes back for centuries, the contemporary name for a fraudulent investment operation of this type is linked to an early 20th century Italian immigrant named Charles Ponzi. After successfully immigrating to the United States in 1903, Ponzi launched an investment opportunity built around the arbitrage of reply coupons. In short order, funds collected from the most recent investors were going to pay returns to the earlier investors, plus help build a considerable amount of wealth for Ponzi personally.
While a Ponzi scheme is often considered to be a variant of a basic pyramid scheme, there are a few subtle differences between the two approaches. While both strategies are examples of an illegal investment scheme that makes use of impressive technical terms and promises of high returns in a short period of time, a Ponzi scheme has a central figure who is the recipient of most of the benefit from the scheme. By contrast, a pyramid scheme involves building a network of investors who also function as active recruiters and who benefit in some way from any investments made as a result of their efforts.
A true Ponzi scheme also does not rely solely on new investors to keep functioning. As a companion strategy, the Ponzi approach will also involve going back to earlier investors who have earned some sort of return on their initial investment and convincing them to reinvest both the original sum plus any profits earned. This also is different from most pyramid schemes that rely on the continual recruitment of fresh or new investors in order to continue operating.
While most countries have laws that make practices of this kind illegal and subject to a variety of penalties, including imprisonment, it is sometimes very difficult to identify a Ponzi scheme at the beginning of the process. As time goes on, the operation of the scheme makes it easier to recognize the strategy for what it truly is and be able to take steps to shut down the operation. However, by that point many investors have sustained heavy losses that are not likely to ever be recovered.