What is a Ponzi scheme or Financial Pyramid?

What is a Ponzi scheme or Financial Pyramid?
A Ponzi scheme is a fraudulent investment scam that promises high rates of return with little risk to investors. The Ponzi scheme generates profits for early investors by attracting new investors. This is itself a pyramid scheme that relies on using funds from new investors to pay off previous backers.

Both Ponzi schemes and pyramid schemes eventually hit rock bottom when the flood of new investors dries up and there isn’t enough money to go around. At that point, the pyramid schemes and systems fall apart.

The Ponzi Scheme Explained

A Ponzi scheme is an investment fraud in which clients are promised a large return with little or no risk. Companies that create a Ponzi scheme focus all their energy on attracting new clients to make investments that are not explained to investors.

This new income is used to pay the original investors their returns, marking them as a profit from a legitimate transaction. Ponzi schemes rely on a constant stream of new investments to continue to provide returns to older investors. When this flow runs out, the scheme falls apart.

Origins of the Ponzi Scheme

The Ponzi scheme is named after a con artist named Carlo Ponzi, who orchestrated the first such scam system in 1919. The postal service, at the time, had developed coupons for letters that allowed a sender to pre-purchase postage stamps and Include a coupon for these in their letters. The recipient would take the coupon to a local post office and exchange it for the priority postage stamps needed to send a reply.

The constant fluctuation of stamp prices meant that it was common for stamps to be more expensive in one country than another. Ponzi hired agents to buy cheap international reply coupons in other countries and send them to them. He would then exchange those coupons for stamps that were more expensive than the original value of the coupon. The stamps were therefore later sold at a profit.

Ponzi schemes rely on a steady stream of new investments to continue to provide returns to older investors,

This type of exchange is known as arbitrage, which is not an illegal practice. But Ponzi got greedy and expanded his efforts.

Under the title of his company, Securities Exchange Company, he promised returns of 50% in 45 days or 100% in 90 days. Due to his success in the postage stamp scheme, investors were immediately attracted.

Instead of investing the money in the postage stamp coupons, Ponzi simply redistributed it to older investors and told investors there was a profit.

The scheme lasted until August 1920, when The Boston Post began investigating the Securities Exchange Company. As a result of the newspaper’s investigation, Ponzi was arrested by federal authorities on August 12, 1920, and charged with various counts of mail fraud.

Red flags of a Ponzi or Pyramid scheme.

Ponzi schemes did not end in 1920. As technology changed, so did the Ponzi scheme. In 2008, Bernard Madoff was convicted of running a Ponzi scheme that falsified trading reports to show that a client was making profits on investments that did not exist.

Regardless of the technology used in the Ponzi scheme, most share similar characteristics:

A guaranteed promise of high returns with little risk.

Constant income stream regardless of market conditions.

Investments that have not been registered with the Securities and Exchange Commission (SEC).

Investment strategies that are secret or described as too complex to explain.

Clients cannot see the official documentation of their investments.

Customers face difficulties in withdrawing their money.

Ponzi schemes in Latin America

In 2007 and 2008, multiple Colombian companies used this business scheme to generate surprising profits. The most recognized company in this type of scheme was DMG, owned by David Murcia Guzmán, who was convicted in the United States for money laundering. Other companies also promised impressive profits, assuring investors that the money would be used to make profits on the foreign exchange market, Forex.

In October 2008 these schemes began to collapse and around December of the same year, the national government intervened in local companies dedicated to this type of scam.

Pyramid scams based on alleged “Forex investments”

Pyramid scams based on alleged “Forex investments”


Germán Cardona Soler, the brain behind Forex Finance fraud.

Two of the most well-known fraudulent schemes in Latin America were Forex Finance and Forexmacro, companies that claimed to invest the public’s money in legitimate brokers through experienced traders. The Forex Finance company, founded by the Spaniard Germán Cardona Soler and promoting itself as the trademark of Evolution Market Group, a company established virtually in Panama, had been established in 2006 and raised money from more than 100,000 people in more than 110 countries. Cardona Soler was captured in Spain in 2011 and was convicted of fraud and securities fraud. The Forex Finance scam is estimated at more than 300 million euros.

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The ForexMacro scam was much bigger, as it positioned itself as the competition of Forex Finance and seemed to offer higher returns. While Forex Finance offered returns of 10 or 12% per month, ForexMacro claimed to offer returns of up to 20% per month.

Many other companies that claimed to invest in Forex emerged in the middle of this period, from 2006 to 2008, since due to the low-interest rates of the Federal Reserve in the United States there was a huge flow of dollars worldwide and the economy experienced a boom, which led to excellent returns that many people did not know where else to invest, the scams of these companies that claimed to invest in Forex took advantage of the excess of existing money to offer significant returns. However, after the 2008 financial crisis when the US and European economies went into recession and many Latin American economies were hit, investors started demanding their money, leading to the inevitable collapse of the scams.

Famous Ponzi Schemes

Bernard Madoff

Unless you’ve been living under a rock, you should all know by now that financier Bernard “Bernie” Madoff was arrested for running a Ponzi scheme. There are four notable facts about his operation:

  • It was the largest (in dollars)
  • It was the oldest (known) Ponzi scheme in history. Researchers who reviewed the registry found evidence of this financial pyramid dating back to the 1970s.
  • It was perpetrated by one of the pillars of Wall Street: Madoff was a former chairman of the NASDAQ stock exchange.
  • His victims are some of the wealthiest and most financially savvy people in the world (it took at least $20 million to “invest” with him).

We’re not going to talk about Madoff (this story is online), but let’s reprint what his website used to say before the authorities put him in jail:

« In an era of faceless organizations being owned by other equally faceless organizations, Bernard L. Madoff Investment Securities LLC harkens back to an earlier era in the financial world: the era where the owner’s name was on the door.

Clients know that Bernard Madoff has a vested interest in maintaining an unblemished record of value, fair dealing, and high ethical standards that have always been the company’s hallmark .” (Published in Bloomberg Media.)

Dona Branca

Maria Branca dos Santos, more commonly called “Dona” Branca, was a poor Portuguese woman who decided that she would open her own “bank” in 1970. To make it attractive, she promised an interest rate of 10% per month and got thousands of clients (including the working poor of Portugal) would give him their money.

The scheme lasted for more than 14 years, and during this time she is known as “the people’s banker “. Doña Branca was arrested and sentenced to 10 years in prison. She died poor, blind, and alone.

In 1993, her crime inspired a Portuguese soap opera titled A Banqueira do Povo (“The People’s Banker”).

European Kings Club

In 1992, Damara Bertges and Hans Gunther Spachtholz founded the European Kings Club, a “non-profit” association that rallied against the big European banks and promised to help the “little ones.”

Investors bought a ‘card’, which was a kind of club share, for 1,400 Swiss francs. This entitled them to 12 monthly payments of 200 Swiss francs, which meant doubling their money in just one year.

The European Kings Club meetings were impressive: they sang their own anthem, and the duo made a show of handing money into the hands of “club members”.

When the plan collapsed 2 years later, some 94,000 German and Swiss investors lost more than US$1 billion. In the Swiss cantons of Uri and Glarus, it was estimated that one in ten adults had fallen for the scheme.

But even after authorities raided EKC’s offices and captured Bertges, her investors still believed she was innocent and a successful banker. When Bertges was put on trial, her “victims of her” applauded so loudly that the judge had to remove everyone from the courtroom. For scamming people out of a billion dollars, Bertges received a 7-year prison sentence and Spachtholz less than 5 years in jail.

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Yilishen Tianxi: Ant Breeding Scheme

If you think previous Ponzi schemes were brazen, check this one out. He caught a million, yes, you read that right, a million people in China…and he did it with ants!

In 1999, Wang Fengyou founded the Yilishen Tianxi Group and came up with a plan so crazy it was brilliant: ant hunting. He convinced poor farmers to give him 10,000 yuan (about $1,500). In return, they received a box of “special ants” and a list of very strict instructions: spray the ants with a solution of sugar and honey at 9 a.m. and 4 p.m. every day and feed them cake and egg yolk. every three or five days. Under no circumstances were they to open the box. Every 74 days, workers from Yilishen would come and collect the ants to grind them up into an aphrodisiac. For their work, the farmers received 13,250 yuan, or a 32.5% premium every 14 months.

In 2006, Wang was a very rich man. His company was featured in the newspapers and on television. He hired celebrities to advertise his company and worked with government officials. He even received the “China’s Top 10 Business Leaders” award from the government.

Its ant aphrodisiacs were sold in some 80,000 pharmacies in China, and by some accounts, more than 1 million people raised ants for Yilishen, giving the company an annual turnover of 15 billion yuan ($2 billion). Dollars).

In October 2007, Wang’s scheme collapsed. The company began to stop making payments, and like ants, thousands of people flocked to his company’s headquarters and government offices. A month later, Wang Fengyou was arrested.

Unlike other Ponzi scheme swindlers who got out after just a few years in jail, Wang’s fate did not turn out well. In the same year that Wang’s scheme collapsed, the Chinese government began cracking down on 3,747 pyramid schemes. Wang’s rival, who tricked people into a similar ant-breeding scheme, was sentenced to death.

Oh, and did his aphrodisiac recipes really work? Actually yes, but not because of the ants. Their products contained sildenafil, the active ingredient in Viagra.

Ponzi schemes and MLM

Are MLM Ponzi Schemes in Disguise?

Multi-level marketing can be a good thing

Multi-level marketing (MLM) is an attractive business proposition for many people. It offers the opportunity to become involved in a system for distributing products to consumers. Unlike the person starting a business from scratch, the MLM participant is supported by a direct selling company that supplies the products and sometimes also offers training.

How does MLM work?

As an MLM consultant or contractor or distributor (different companies call them different things), you make money by selling the products to other MLM participants. If they are not already a member of your MLM company, you must enroll them.

In addition to earning money from your own sales, you also earn a percentage of the income generated by the distributors you have brought into the program (these are known as your downline). There are often bonuses for selling particular quantities of products or signing up a certain number of new members; you can win cars and rides as well as cash. Sounds good, doesn’t it? And being part of a well-run MLM business can be a lot like being a member of a large extended family.

Pyramid schemes

Unfortunately, not all multilevel marketing opportunities are legitimate business opportunities. Many are pyramid schemes, and frauds designed to separate the unwary from their money, they are disguised.

Like multilevel marketing, pyramid schemes rely on recruiting people to become distributors of a product or service. Like MLM, the pyramid scheme offers the opportunity to earn money by enrolling more recruits and achieving certain levels of ranking or qualification.

The big difference between multilevel marketing and pyramid schemes is that MLM is legal in Canada (and most of the US) and pyramid schemes are not. Participating in a pyramid scheme is a crime under the Criminal Code of Canada, punishable by up to five years in prison.

But it can be very difficult for the person looking for a business opportunity to distinguish between a legitimate MLM opportunity and a pyramid scheme at a glance.

In the past, highly positioned and important companies in the MLM industry such as Amway and Herbalife have been accused of being pyramid or Ponzi schemes disguised as MLM. Investor Bill Ackman accused Herbalife of being a pyramid scheme and launched a million-dollar stock market bet against the company. Within a few years, another investor, Carl Icahn, bet on Herbalife by buying a large number of shares and saving the company from collapse. Shortly after this, Ackman backed off his bet and went home with losses in the millions.

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The case of Nu Skin in Argentina

The case of Nu Skin in Argentina


Nu Skin has been accused of being a pyramid scheme masquerading as MLM.

In the year 2020, when many people were confined to their homes due to the coronavirus pandemic, the company Nu Skin, an American company based in Utah, came under heavy criticism in Argentina and was accused of being a pyramid scheme. With many people losing their jobs due to the pandemic, Nu Skin was marketed as a way to continue earning money from home and online, which was ideal amid lockdowns.

Several well-known influencers were promoting Nu Skin beauty products and were criticized for not doing enough research before promoting the Nu Skin brand, business opportunities, and products. In the case of this company in particular, what has been denounced is that it mainly seeks the registration of distributors before new clients and the fact that distributors are forced to make monthly purchases and thus be able to “qualify” to access the commissions granted by the company.

The fever for cryptocurrencies and their relationship with Ponzi schemes

Since the invention of bitcoin, various fraud schemes that take advantage of the furor over financial speculation around cryptocurrencies have been happening with increasing frequency worldwide. The ability of these coins to rise in price at a rapid rate has led many people to believe that they can become rich in a short time by investing large amounts of money in allegedly managed funds that claim to operate for them in the cryptocurrency market and offer returns. substantial.

The fraud models in these scenarios are typical Ponzi schemes where money from new members is used to pay off old members who start claiming their money over time to reap benefits.

Generally, the companies that use this fraud model force their affiliates or investors to initial investment terms in which they will not be able to withdraw their money. These terms can range between four and six months depending on the company.

The OneCoin scam

Ponzi scheme


Ruja Ignatova, promoter of the OneCoin fraud.

In the world of investment with cryptocurrencies, one of the scams with the greatest impact was of OneCoin, a company founded by the Bulgarian fraudster Ruja Ignatova. The New York Times described OneCoin as one of the biggest frauds in history. Ignatova was the subject of a BBC documentary called “The Lost Crypto-Queen,” in which victims of the scam told her story and speculated where the scam artist might be.

In early 2019, Ignatova was tried and convicted in absentia in the United States for financial crimes including computer fraud, securities fraud, and money laundering. The OneCoin Ponzi scheme had been founded in 2014 and had been promoted as the competition of bitcoin, the author of the fraud assured that it offered financial education to its clients and a unique currency model that would soon be used as an exchange currency on the internet. massively for purchases of goods and services, unlike bitcoin which was only used for speculative purposes.

Towards the middle of 2017 the fraud was discovered, although it continued to operate in some Eastern European countries in which many investors still did not believe the news. A brother of Ignatova, Konstantin Ignatov, continued to lead OneCoin after Ignatova fled from justice, shortly after Ignatov was captured by US justice and began collaborating with the authorities in the hope of obtaining reductions in his sentence.

2019-2020, the fever for Ponzi schemes intensifies

On June 30, 2020, the daily Technology Review reported that in 2019, “millions of people fell victim to fraudulent schemes claiming to be cryptocurrency investments.” The amount of the scams, only in 2019, amounted to 4,300 million dollars.

In mid-2020, in the midst of the global coronavirus crisis and following the spectacular rise in the price of bitcoin, fraud based on cryptocurrency Ponzi schemes increased dramatically. Numerous companies emerged claiming to manage cryptocurrency assets on exchanges. The big problem with this is that some companies do indeed carry out this type of operation, but many others took advantage of financial speculation around cryptocurrencies as a way to capture public attention and money.

By the end of 2020, with bitcoin prices rising to all-time highs and more and more people interested in harnessing the potential of bitcoin to make their fortune, pyramid schemes continued to rise. Many of these companies claim to be MLM schemes where affiliates are paid to bring in new affiliates and a simple look at their compensation plans makes it very easy to see that such returns are mathematically impossible. However, it is not surprising that many people fall for this type of scam, because the scams are promoted as investments “made by expert traders”.

With information from Investopedia.


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