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Ponzi schemes - earning on new members

Ponzi schemes - earning on new members. How does this thing work and how does it end? We have tried to find out something about it.

What does fraud business mean in this modern world? What did it mean before? The difference is probably the fact that the creators of a fraud business can do it much easier and faster by using Internet. But the technology behind it is the same. Regardless if the owner of that kind of business decided to do it 100 years ago or today. His or her idea is the most important detail. In this article we are writing about Ponzi schemes, so the question is, what is it?

Actually we became interested of Ponzi schemes after listening on a podcast called Die vermisste Millionärin from Weird Crimes at Antenne Bayern. How does Ponzi schemes work? We can try to go back in time and learn more.

Some history

Ponzi schemes is connected to Pyramid scheme and that is something that can explain the functionality of this kind of fraud business. An Italian man called Charles Ponzi was born in northern Italy in 1882 and he had a very poor life.

As a young man, he studied at Sapienza University in Rome. He was not a perfect student and after four years he decided to leave Italy, with no money and no degree. During his university time, he had heard stories about other Italian people who moved to America to find a better life. He decided that this was the only course left open for him.

In the USA he learned more about business and especially about arbitrage which means simultaneous purchase and sale of an asset in two different markets. Tiny differences in price allow for a modest profit. In his case, buying IRCs in Italy for one price and exchanging them for higher-priced postage stamps in the USA would create significant profit when done at scale. That is how everything begun according to investopedia.com.

According to that article, In 1920, Ponzi organized a company called Securities Exchange Co. in which he sold stock (promissory notes) advertising 50% interest after 90 days. He raked in $15 million ($220 million in 2022 dollars) in the first eight months of 1920.

How does Pyramid scheme work?

About Pyramid scheme we can read more in this investopedia.com article and we can see that the compensation structures resemble a pyramid. The scheme starts with a single point on top. The original members are there and they recruit some new members. The scheme becomes wider toward the bottom as new members on every level do recruit new members.

For example a man recruits 10 people with some promise of a big return on their money. They're represented by the level directly below him on the pyramid. Each of those new, 10 members, or participants, pays the man who recruited them a certain fee to take part in the opportunity he's offered them. Then, each of those members is encouraged to recruit 10 more members, for a total of 100 members.

Now each of those 100 new recruits must pay fees to the recruiters on the level above, who must send a percentage of their earnings up to the man who recruited form the start. This recruitment and payment cycle repeats over and over again for as long as possible. Here we can see that money continues to flow upward to those in the levels above.

The emphasis in Pyramid scheme is on recruiting new members. There is no identifiable source of income other than that coming from those recruited. How does it end? Pyramid schemes can survive as long as new, paying participants continue to come in. Since the pyramid base must continue to grow, the entire structure collapses when the available members or participants disappear.