These days, there are many ways to invest your money, but there are also increased chances for people to scam you. Ponzi schemes, which can trick even experienced investors, are still making it to the news. These schemes promise big returns without much risk, but they're often different from what they seem.
If a deal seems too good to be true, it probably is. How can you tell if someone is running a ponzi scheme and keep your money safe?
Introduction
What is a ponzi scheme?
This is an investment scam that promises a high return with very little risk. So, what's the trick? The money returned to old investors comes from the money collected from new investors.
Basically, ponzi schemes are a type of investment scam that can have devastating consequences for participants. In a Ponzi scheme, returns are paid to existing investors from funds contributed by new investors, rather than from profit earned.
The origin:
The term ponzi scheme was popularised after Charles Ponzi, a notorious fraudster, most famous for his investment scheme involving postal return coupons. Ponzi's scam was enticing enough to draw numerous investors before its eventual failure, resulting in massive losses.
The dangers of ponzi schemes
Investors are often left to pay for the activities of ponzi schemes, sometimes through far greater than money loss. These schemes can suck up credibility in capital markets, discredit earnings, and leave entire families devastated. Since everyone in this field should be aware of such schemes, it is equally important to know the signs and safeguard oneself from ploys of this nature.
Workings of a ponzi scheme
At its heart, a ponzi scheme is like a bucket with holes in it. Fresh money from new investors is used to reward earlier investors, but there's no actual profit being made. It's a never-ending loop of convincing new individuals to invest while using their cash to make it appear as though others are earning returns.
How does a ponzi scheme work?
Promising high returns: Ponzi schemes attract investors with promises of above-average returns, often with little or no risk involved.
Paying earlier investors: Instead of making real profits, the scheme pays earlier investors using money from new investors.
No real investment activity: These schemes usually involve very little or no actual business or investment operations.
Example: In India, a major case unfolded involving Sahara India Pariwar. The company collected a large amount of money from small investors, promising a high return through bonds. However, instead of using the funds for investment, Sahara allegedly diverted them into other business ventures. The Securities and Exchange Board of India then stepped in, claiming that Sahara was involved in a large ponzi scheme that affected millions of investors.
The life cycle of a ponzi scheme
Attraction phase: In this phase, the promise of fast, high returns from the people running the scam attracts early investors.
Expansion phase: As people start making money, the word spreads, and even more people join in, which adds to the influx of new money.
Collapse phase: Eventually, the scheme falls apart when there aren't enough new investors to keep making payouts, leaving most people with significant losses.
Types of ponzi schemes
Traditional ponzi schemes: These schemes are fairly simple, they promise high returns with little to no risk. Investors think their money is being used to make a profit, but really, new investors' money is used to pay off earlier investors. When it slows down, the scheme collapses.
Pyramid schemes: Pyramid schemes are similar to Ponzi schemes but with a twist. People earn money by getting others to join rather than selling a real product or service. As the scheme gets bigger, it gets harder to keep going, and it eventually falls apart. The focus is on getting recruits everytime, not on real investments or sales.
Affinity fraud: Scams target close groups, such as religious groups or professional networks. Scammers take advantage of the trust within these groups to get new victims. By using these connections, they make it harder for people to doubt the scam until it's too late.
Online ponzi schemes: With the rise of digital investments and cryptocurrency, online Ponzi schemes are becoming more common. Scammers promise big returns through complex digital ventures, often using technical jargon to sound convincing. These schemes can be hard to track and thrive on the excitement about new technology. Examples include cryptocurrency-based scams like BitConnect and OneCoin, where investors were promised huge profits but ended up collectively losing billions when the scams were exposed.
Famous ponzi scheme cases
Charles Ponzi: The original scam involved Charles Ponzi, who promised investors high returns through international postal reply coupons. Thousands invested before the scheme collapsed, leaving many in financial ruin.
Saradha chit fund scam : Saradha chit fund scam was a major ponzi scheme in India. Based in West Bengal, it collected around ₹2,500 crores from over 1.7 million people who deposited money expecting extremely high returns. This scheme eventually collapsed, leaving thousands of investors - many of whom were poor - in a devastating situation.
The rose valley scam: The rose valley scam was another case of a chit-fund scandal. The group deceived investors out of ₹17,000 crores by promising unusually high returns. It only kept going by bringing in new investors, just like the Saradha scheme.
Cryptocurrency scams
BitConnect: Promised massive returns on crypto investments through a lending program. When it collapsed, many investors were left with worthless tokens.
OneCoin: Marketed as a revolutionary cryptocurrency, OneCoin turned out to be a fraud, with billions lost globally.
These cases show how Ponzi schemes often target ordinary people who invest their money, hoping for financial security, but end up with nothing.
How to identify a ponzi scheme
To avoid falling into the ponzi trap, watch out for these signs:
Returns that sound too good to be true: Be cautious if someone promises unusually high returns with zero risk. All genuine investments come with some level of risk.
Unregistered investments: Always verify if the investment is registered with a regulatory body like SEBI. If it's not, think carefully before investing.
Lack of openness: If you're told something is too complicated to explain or that it's a secret strategy, be wary. Genuine investments are transparent and easy to understand.
Pressure to bring in new investors: If you're pushed to recruit new investors to earn more, it's a warning sign. This tactic is often used in ponzi schemes.
Precautions to avoid ponzi schemes
Now that you know the signs, here are a few steps you can take to protect yourself:
Do your research: Always research the company and its track record. In today’s digital world, a quick Google search can reveal a lot. Check for any SEBI warnings or legal actions against the company.
Avoid blind trust: Even if friends or family are involved in the investment, don’t just take their word for it. Ponzi schemes often spread through close-knit groups, creating a false sense of trust.
Stay cautious of high returns: In India, the typical returns on fixed deposits hover between 5-7%. So, if someone promises you 30% or more returns, pause and ask questions. How are these returns being generated? If the answers are vague, walk away.
Seek professional advice: When in doubt, consult a certified financial advisor. They can help you spot red flags and guide you towards safer investment opportunities.
The NSEL scam
The National Spot Exchange Limited (NSEL) scam was one of India's biggest financial scams. It was discovered in 2013 and left investors with losses of ₹5,600 crores. NSEL said it could give investors safe returns through commodities trading, but it was running a ponzi-like scheme. It gave fake warehouse receipts for goods that didn't exist and used money from new investors to pay old ones.
People like Jignesh Shah, who started NSEL, were accused of being behind the scam. Some brokerage firms and borrowers were also involved. When it all fell apart, investors were left with nothing.
This scam led to more control from SEBI, which now watches over commodity exchanges. It's a reminder for investors to be careful, check everything, and be suspicious of anyone who promises guaranteed returns.
Bottom line
Ponzi schemes usually take advantage of people's greed, fear, and lack of knowledge. The more you know, the better you'll be at avoiding their traps. If an investment seems too perfect, it probably is, so always be careful and make smart choices.
By being aware of these schemes, you can keep yourself and others safe from financial scams.
In finance, knowledge is your strongest defence—stay informed and stay safe.
