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Ponzi Scheme: Important Topics for UPSC Exams

What is a Ponzi scheme?

It is a deceitful investing scam with two promises which are high rates of return and little risk to investors.
It is so designed that it generates returns for older investors by acquiring new investors. Therefore, Similar to a pyramid scheme in the sense that both are based on using new investors' funds to pay the earlier backers.
Both these schemes that are Ponzi and Pyramid eventually fails because there isn't enough money to go around and around for much longer.
They are considered as illegal in most of the countries.

How does a Ponzi scheme?

Suppose that there is a company XYZ which sells products in the healthcare industry to only those people who are either the employee of the company or related to them. Now suppose for every sells that happens the profit goes from top to bottom in the ratio of the relationship linkages. Therefore suppose is CEO of the company then he/she will get the maximum benefit then the next guy to him/her will get the benefits and it will continue like that. At the end of the cycle, the people who invest in the scheme at the end will get paid very less as compared to other people and further if sells do not happen up to say certain quantity 10000 then the one responsible for it won’t get paid. But here, other guys above to him/her will get paid because they must be having 3-4 people below them to complete their required number.

Thus eventually, profit erosion start from the last leg of people who invest in the scheme and the promoters get the maximum benefit for a long time.

Example

In 2008, the largest Ponzi scheme in the history, led by financier Bernard Madoff was caught. The scheme duped investors of almost $65 billion over a period of 17 years.

How did Ponzi schemes get their name?

It was named after Charles Ponzi, who duped thousands of people in a postage stamp speculation scheme back in the 1920s.
Ponzi promised investors that he could provide a 50% return in just 90 days whereas in those days bank interest rates were only 5%.

Impact of such schemes in society

Many people get duped and they loose their hard earned money by investing in such schemes.
If such schemes spread to very large people it may impact the financial system and therefore trust of people in the financial system may decline.
Moral degradation in society since people gets inspired for huge gains with little risks and thus may cause negative behaviour development and that will not be good for the larger society in the long term.