Ponzi schemes - how they work

Since I'm feeling nice, I figured I would post sort of a brief sketch of what a Ponzi scheme is all about, for the benefit of people who are unfamiliar. Most people have heard the term "Ponzi scheme", but don't know exactly what makes a certain scheme a Ponzi scheme. Allow me to explain!

A Ponzi scheme, simply put, is a way of getting rich by convincing other people that you can get them rich. Here's how it works. Ponzi schemes typically have a single schemer - perhaps he's sharing the wealth with others, but generally there's one guy at the center of the spiderweb. He'll come to you and say, "I have found a way to invest money with little to zero risk and incredible growth." Typically, his investment method will remain secret, or ambiguous - even to his investors. It has to be this way, he will explain, because his investment method takes advantage of a "loophole" (that's a very important word here) that, if everybody knew about it, would be regulated and shut, and the opportunity for making money would no longer exist.

So he will say (the numbers could be anything believable, or even slightly unbelievable - let's make something up for this example), "You give me L$10000, and after one month in my system, you'll have turned it into L$20000 guaranteed". So you figure, OK, let's see about it. You pay him the L$10000, and one month later, presto - he has L$20000 to give you, just as promised! He'll likely pay it to you, and then say, "You know, if you put that L$20000 back into my system, in another month it will be L$40000..." This is entirely believable because, after all, he made good on his initial promise didn't he? What you don't know is, your initial L$10000 wasn't invested in anything at all. It just sat in his account. Thing is, he "recruited" about 10 people into his scam, which means he made L$100000, a tidy fund from which the L$20000 teaser he gave you back isn't so big a loss.

So you put your money back into the system. You're told that next month, it'll be $40000. The following month, L$80000. Then L$160000. And so on, and so on. Meanwhile, he keeps recruiting more people - with your help, because you're convinced the system works, and you spread the word. He recruits 20, 40....100 people, and now he has amassed L$1000000. Every once in a while, somebody gets suspicious, or nervous, and asks for a payout - which he grants; he'll pay somebody their L$160000 (which of course isn't really money gained, but is simply money paid in by other investors), and he'll make sure everybody knows about the payout, because it "proves" the system is honest and working...which in turn attracts more investors, and keeps the current investors paid in. Some of them might even pay still more of their own real money in - you can only turn it into more money, after all.

The schemer will keep this going as long as he can get more money out of it - and as long as he can keep the investors in line. Perhaps he imposes (may have imposed from the very beginning) a "limit" on exactly how much an investor can "withdraw" at any one time - thus keeping somebody who's supposedly gained something like half the total money the trickster has made off the scheme from cutting too deeply into his profits.

At some point, something happens - either too many people request too high of a payout at once, or the pool of new investors dries up. At this point the website suddenly goes down, the phone number is disconnected, the avatar account is deleted, and the schemer has made off with millions and millions of linden dollars, which he's converted into who knows how many thousands of real dollars. If you want to be technical about it, *you* have only lost that L$10000 you put in at the beginning - because you never really made that L$160000, none of that ever really existed, because the money was never really invested in anything except the schemer's pocket. But if you made plans, did things on credit because you were certain you had all that money, you could be in trouble. And if you were convinced to pour more real money into the system, well...the joke's on you.

Curiously enough, as an investor, there is a chance you CAN make real money out of the Ponzi scheme - if you've been "invested" a while and are lucky enough to request a large payout before the scheme collapses (i.e., you're one of the people the swindler uses to "prove" his scheme is legit), you could make out like a bandit. But it requires a lot of luck, and is very difficult to do consciously - people scheming to make money usually want to make as much money as possible, and since it's likely you'll never know when the scheme is about to collapse until ten minutes after it has, more often than not you'll have waited just a bit too long and will still be a victim.

Anyway, that's what a Ponzi scheme is, basically. It's named after a fellow named Charles Ponzi, although he was not the first to use such a scheme. His scheme in the early 1900's involved buying postal reply coupons in one country, then selling them at another country's currency exchange. Theoretically, if there was the right kind of difference in the two countries' exchange rates, one could make a profit (this is called arbitrage and is legal). Ponzi did this and got other people to invest by exaggerating the profit margin obtainable through this sort of system; at some point he was making so much money from peoples' investments that he stopped actually buying the postal coupons and just kept the money, using other investors' money to pay off any requests for payouts - not that there were many requests. Everybody kept "reinvesting". After many years, somebody figured out that for Ponzi's scheme to be legit, there had to have been 160 million postal reply coupons purchased and in circulation - fact-checkers learned that, worldwide, there were less than 30,000 circulating. Thus the scheme started to crumble and Ponzi was eventually arrested and indicted for fraud. Modern swindlers have a more intuitive grasp of when the end is near, and disappear themselves before the investigators come a-calling. Curiously enough, when the scheme was exposed, there were a great many people who refused to believe it was fraudulent; they supported and praised Ponzi and attacked the investigators as jealous systemites who were angry that Ponzi had found a way to break the class barrier. Modern investor-victims of Ponzi schemes, especially ones that bought into the scheme early (usually personal friends of the swindler) will be just as protective of their swindlers. One such fraud, exposed in 2000, called the "Omega Trust" had built such a loyalty amongst its investors that when the schemer was convicted, jailed, and ordered to pay restitution, dozens of the investors flat-out refused to come to the clerk's office to collect their money, because they had convinced themselves that if they held out and "remained invested", they would eventually receive their promised payouts after all, when a special, mythical finance bill was passed by Congress (it's a long, complicated story).

So, how can you tell when an investment "program" in SL is in reality an illegal Ponzi scheme? Well, until the schemers run off with your money, there's no way to tell for sure. But there -are- a couple of red flags which should make you suspicious. The biggest is if the company or individual keeps the details of their investment strategy a secret. They'll spend a lot of time trying to convince you that if they made the details public, the "opportunity" would disappear - don't fall for it. If you're told the supposed strategy takes advantage of some obscure "loophole" that nobody else but this guy/company knows about, be careful. If the amount of money you're permitted to withdraw is restricted in any way, be really, really careful - there's no real reason you shouldn't be able to withdraw all your assets at once, whenever you want. Again, none of these is incontrivertible evidence; but they should definitely make you stop for a moment and say, "hold on....".

You described the modern banking system to a T, minus the "promise of huge returns" part.

That is the primary difference. Banks promise returns, but they're ridiculously small, and the money really is invested. Unfortunately, real investments can depreciate - which a couple of banks, and their account holders, have learned in a rather painful way recently.

The hallmark of the Ponzi scheme is "get rich quick". Double your investment is somewhat typical; triple or quadruple is not unheard of. Some might promise a smaller return, to allay immediate suspicion - but in any case, it's claimed you'll get rich. Nobody could ever accuse a bank of suggesting you could get rich off their awesomesauce .8% APY.

Good description, Dakota. This is how chain letters work too: "Mail $10 to the person at the top of the list then add you name to the bottom of the list and mail copies of this letter to 10 new people. When your name gets to the top 1,000,000 people will send each you $10." It's also called a pyramid scheme.

Yes! Although a pyramid scheme is a little different from a Ponzi scheme.

Well, in the most technical sense, no - Ponzi is a pyramid, in that you've got a small "peak" (the swindler, or his company) at the top, and a wide base (all the investors); but it's different from what people commonly mean by "pyramid scheme". In a Ponzi scheme, all the investors deal directly with the schemer himself - all the money goes to him, and there's no in-between. He's like the hub of a wheel, and all the investors are spokes.

In the more common pyramid scheme, in order for you as an investor to see a return, you must create a "downline" - recruit other investors to pass money up to you - and only by creating a big enough downline will you see the profits. One setup is the "conveyor line" you described. Another method is the exponential pyramid - let's say you're required to recruit 4 people, who each in turn must recruit four people, who each in turn must recruit four people, in order for you to be "promoted" into a money-making position in the line. Once you're promoted, the whole tree "moves up", and the 4 you've recruited are now in your former position, having to make sure their downlines keep growing, so that they too will be promoted. In all these pyramid schemes, many people besides the initial schemer have a chance to make a lot of money - as long as more recruits are added to the end of the line, or the bottom of the "pyramid", things will continue as always. The problem is, after some 20 iterations (maybe less), your pyramid's bottom tier would have to recruit a number which exceeds the entire population of the earth in order to progress; as a result, nobody moves up anymore, the scheme collapses, and the bottom two or three tiers (consisting of the vast, overwhelming majority of investors) completely lose their investments.

Hmm cool idea except in SL you would join his scheme with 10 alts and when he gives you the $20k to each do a runner with the cash

The more you know....

http://en.wikipedia.org/wiki/Ponzi_Scheme

http://en.wikipedia.org/wiki/Charles_Ponzi

http://en.wikipedia.org/wiki/Bernard_Madoff

Ponzi scheme in SL:

1. Convince 1,000 people to invest 1,000 linden in your company.

2. Walk away with the money as LL will not get involved with investigating the ripoff.

3. Grow an alt. Rinse, repeat.

OK, not so much "ponzi", but certainly easier.

As you say, that is not a ponzi scheme. But it is a type of fraud that is not unknown. Maybe it hasn't happened in SL, but it has in RL.
Mary

i would say with the recent crisis the banks were pretty much doing just this very thing.
Taking lots of mortgages clumping them together for collateral for even bigger loans to play with and to lend more to even more people with bad credit to make the market look plush..
if they would have been happy with the percentage they were getting from the home loans and also not letting everyone play buy giving out loans to people that had no business getting the loans we would not be in the situation we are in right now..
but give corporations hiding behind the name bank a deregulated market area and they are gonna take advantage of it.
and they did.

Indeed. The banks whose boards were able to check their greed long enough to stay out of the subprime loan business are deservedly patting themselves on the back right now, in my opinion.

One of the more unfortunate parts is, some of the mega-banks that failed because of this situation did not, themselves, actually hand out the subprime loans. Rather, they simply underwrote the banks that decided to do so, and in this case the, uh, waste flowed uphill, too. Whoops.

There's a REASON people with bad credit have bad credit, and by and large that reason is because they simply don't pay you what they promise to pay you. Why these banks thought they could change that with a little candy is a mystery I'll never be able to solve (not that I'm spending a lot of time on it).

i really don't think they cared about the loans getting paid because they had assets good assets in the houses..the thing is they did not take the time to think that this would cause the housing market to drop lowering the asset they had in holding when things would come to a head..

basically they just wanted to have more money to play with and that takes good assets to start the game..

the only thing is when you have 10 mortgages out on loan you don't have the asset anymore you have a loan and are gambling with everyones mortgages..

now the loan that is taken out by the bank is also clumped together by an even bigger player clumping all their loans together getting more to play with and the beat goes on..only there were no top players in the game..just a lot of people borrowing back and forth from each other..

the banks were handing these loans back and forth pretty much playing hide and seek building bad assets but making the market look golden and healthy..ok i'll borrow from you and you borrow from me and we'll use this second set of books over here that is not regulated by anyone..
you lure in more investors then have more to play with..
the thing is there came a point of having to show assets and someone said..wait a second..there is no way this is possible..i want to see what my money is invested in..
when they started to get into troube is when they started to call in loans..

when your loan gets called in and you don't have the money you have to reverse the process and call upon the people below you that you have clumped together to pay off their loans for the money..the ones that should have never got the loans in the first place lol..


so really it was nothing but a huge con game going on..Emron on steroids more or less..
the ones that did not play in the world market were not affected as much..only by the backlash to the economy..

it's a real long chain of events and so many details but really nothing more than con men gambling with air making it look like there was something there..

Yes. Good clarification.



I wonder how easy it would be to part 1,000 people from L$1,000 each? Some people do seem to have a knack for appealing to the greed of others in such a way as to get them to suspend their disbelief...



Good references -interesting articles.



And it seems that even when the institutions start to crumble the individuals who set the eventually disastrous policies still are able to walk away with big personal profits in the form of salaries and bonuses.



Everyone involved seems to find it easier to believe that somehow they will end up super rich than to actually figure out what is really going on.

Exactly and they were all having so much fun congratulating each other for being masters of the universe that they were able to ignore reality.

darn it Dakota. you have just foiled my big plans. now none of the forum people's will invest in me. *shakes fist*

There was the Ginko Financial Ponzi Scheme here in SL which stole many hundreds of thousands of USD$ from their investors. It has been estimated that over $700,000.00USD were stolen in the scheme. I tried to warn people for years, but no one listened and many lost their life savings.

There is also the World Stock Exchange, which stole many many tens of thousands of USD$ from their users.

There were many others who did the same and there are "funds" and "exchanges" RIGHT NOW in SL who offer 50+% returns through "secret systems" they can't talk about.

This is exactly why LL should amend the banking ban to include ALL financial operations in SL, which would normally be regulated in the real world. They are illegal and more than likely a scam waiting to implode and steal many more hundreds of thousands of USD from SL users.

See my thread all about these scams.

/327/0d/258501/1.html

Good luck!

the thing is they were giving themselves million dollar bonuses the whole time..
Paulson was the one that played that he was there to save the companies too bg to fold and he was really only there to save the CEO's..
he asked for an unregulated 700 billion lol
the power to never question what he does with the money..and he got it!! hahahaha

so he invests in these dupe companies with the wooden arrows and other junk which i think if you would dig and dig find some of these CEO's owning somewhere along the line..then letting the ones too big to fold ,fold anyways saying he now feels they are not good to save anymore..not even a month after getting the bailout money..

all on no plan but the words trust me and a bunch of studdering double talk lol

now everyone is sucked into the bad market being tax payers paying back for these bad loans but the thieves themselves..

you can bet the Fed loved all the borrowing they did too..they love to see all the banks in trouble..it's swoop in and get any good assets we can time because these guys are looking for money and we have it to dangle infront of them..
waiting for this bailout they were borrowing from the fed in a day almost more than the bailout they got from the government..for like a week they were breaking records..not even really dealing with investors anymore..because the fed was handing out money to play with..

bleh..it just goes on and on hahahaha and it keeps getting even more confusing as each day passes because the game is not over yet and won't be for a long time..

i'm out of air hahahah

I trust you 3, How much should I write the check for?

It's hard to imagine that the decisions made by the Fed's board of directors isn't heavily influenced by the personal interests of the members and and their friends.

well a lot still don't know the fed is privately owned by it's stock holders..it would probably be even worse if the government did control it lol
their stock cannot be sold so they don't enter into the world market..they just do real well when the rest do real bad hahahahaha

When we had the banking issue here, many people were quick to say that real banks wouldn't collapse like the banks here did when LL banned them and that real banks would have had the funds to repay everyone. Now the banks here were badly run and people here are way too trusting but it seems that the RL banks weren't as well run as those who were quick to point the finger believed.

It seems as if a competent government (oxymoron?) would be able to run it for the benefit of the whole country. As it is apparently the private interests (who ever they are) skim a profit from everything that goes on. Which presumably comes out of the taxpayer's pocket. It certainly doesn't seem to be particularly transparent.

Sad but true.

If l give you $1000L and you can return me $2000L then I'lll find you an alt...... I mean person who will invest $1000L who will be able to find you another alt.... I mean person

The 12 regional Federal Reserve Banks are owned by their member banks. Each regional bank has a 9 member board of directors, 6 of whom are chosen by the member banks. However, the 7 member Federal Reserve Board of Governors (the group we usually think of when we hear "the fed" is appointed by the President (with the usual Senate approval requirement). They, in turn, appoint the other 3 members of the boards of each of those 12 regional banks, including the chairman of each of those 12 boards.

It's a complicated system, and I won't pretend to understand how the control is balanced, as a practical matter, between the member banks and the Federal Reserve Board. However, I think it's a mistake to suggest that the government has no direct control.

See http://en.wikipedia.org/wiki/Federal_Reserve_System for more info.