Five Facts About Ponzi Schemes: From King-approved Pyramids to Ant Farming
The Ponzi scheme is named after Charles Ponzi, perhaps the most unlucky con man in history. He was a millionaire for less than two months but gave the world of finance a resounding term.
Today, let’s find out where he stole the idea for a Ponzi scheme, how the king of France promoted a financial pyramid, and how bankrupt ant farms nearly derailed the Olympics.
Fact #1: Ponzi Schemes Are Easily Recognizable
A Ponzi scheme is a different name for a financial pyramid. The first investors get their payouts from the investments of subsequent investors.
For example, Alice contributes $1000 to the pyramid scheme in the first month. In the second month, Bob also contributes $1000. In the third month, the organizers return Alice her $1000 plus a $500 “profit” from Bob’s contribution. Alice will likely put her $1500 back into the pyramid and recommend it to her friends, from whose deposits the organizers will pay Bob’s “profit.”
Pyramid/Ponzi schemes can be recognized by:
- Fixed returns. Real projects most often make money on commissions and state the return as fixed X% of users’ transactions rather than fixed Y% per annum;
- Questionable and complicated way of making profits. It may be arbitrage, trading with supposedly innovative strategies, financing risky projects;
- The need to block funds for a long time. Real projects allow the withdrawal of deposited funds at any time or with a cooldown period of up to a week. Ponzi projects require long-term investments with no possibility of early release of funds;
- Aggressive advertising. The project has too many positive and paid-for reviews. Influencers shill the project and try to attract as many investors as possible — not users, namely investors;
- The anonymity of the creators. Nothing but names are known about the Ponzi project team.
The best way to keep your funds away from scams is to do thorough research and calculate whether the project can make the promised profit from the activities it describes.
Fact #2: an Exposure of a Ponzi Scheme Won a Pulitzer Prize
In short, The Boston Post exposed the machinations of Charles Ponzi. The articles became so popular that the paper won a Pulitzer Prize and the moniker “Ponzi scheme” became a household name.
Charles Ponzi came to North America from Italy in 1903. He was first fired from a restaurant for stealing, then jailed for check forgery, then jailed again for helping someone illegally cross the border.
In 1919 Ponzi received a letter from Spain to which a return coupon was enclosed. This could be exchanged for a postage stamp; thus, senders pre-paid for return letters. Ponzi noticed that because of currency volatility, such coupons were cheaper in Europe than in the United States.
Ponzi tried to get a loan from a bank to buy coupons, exchange them for stamps and earn money. He was turned down.
Then Ponzi decided to raise capital another way: he placed an advertisement in the Boston newspapers promising 100% profit in 90 days to those who would provide him with means for coupon operations. In fact, he left the coupons and stamps as a cover and immediately planned to pay out profits to investors from attracting new deposits.
In January 1920, people invested $1800 in Charles Ponzi’s scam, $25,000 in March, and $2.5 million in June ($33 million adjusted for inflation).
In July, The Boston Post published an article in which the Dow Jones & Company financier denied the very possibility of making money from stamps. He calculated that it would take 160 million postage coupons to turnover such capital, although in reality, the US and European postal services have issued only 27,000 of them.
The Boston Post’s article caused panic, and depositors stopped reinvesting profits. In August, the paper ran another piece explicitly calling Ponzi insolvent. Charles sued the newspaper for defamation, demanding $5 million ($63 million adjusted for inflation).
In late August 1920, state authorities accused Ponzi of embezzlement and mail fraud: the documents suggested his company was illegally “cashing” postage coupons.
In 1921 The Boston Post won a Pulitzer Prize for a series of articles about Ponzi. The name caught on, and since then, American journalists have called all pyramid schemes by his name.
After the confiscation of all assets of the company, Charles Ponzi still owed $10 million, or $134 million, at today’s rate. The US government undertook to compensate for the damage and returned the money to the defrauded depositors before 1930.
Fact #3: the Very First Ponzi Scheme Was Approved by the King of France
In 1716 in France, the economist John Law founded a bank that issued banknotes backed by gold and silver. The French liked using paper money, and the economy began to recover.
In 1717, Law established the Western Company for trade between the colonies of North America and France. Moreover, King Louis XV of France gave him the exclusive right to import beaver skins and tobacco and various privileges.
Law financed the Western Company by selling shares. He sold them for precious metal coins and repurchased them for his bank notes.
Shares rose in value, investors sold them regularly, and the paper stock increased. Three years later, the gold and silver in Law’s bank only covered 10% of the notes issued. In 1720 the company failed to cope with the demands to exchange the banknotes for metal and went bankrupt. John Law soon fled France.
Later, other swindlers also used banks to cover up their machinations.
- In 1879 Sarah Howe opened the Ladies’ Deposit Company with deposits at 8% a month;
- In 1899, William Miller created Franklin Syndicate with the promise of 10% weekly profits;
- In 1907, Luigi Zarossi’s bank offered 6% per annum on deposits and explicitly announced that part of the payout for old depositors would be taken from new investments.
Addendum to fact #2: Charles Ponzi worked for the Zarossi bank before the coupon scam. He wrote in his memoirs that he got the idea for the pyramid scheme from there.
Fact #4: the Most Resilient Ponzi Scheme Worked for 45 Years
In 1960, 22-year-old Bernie Madoff used his $5,000 savings to found Madoff Investment Securities and start trading securities. He helped found the NASDAQ stock exchange, became one of the top 25 stock market participants, and was involved in philanthropy.
In 1973, Madoff offered investors up to 46% per annum by trading on the stock exchange. In practice, it paid investors an annual return of 13%, which was also higher than the average result of trading firms.
By the end of 2007, investors had invested $17 billion in Madoff Investment Securities. In December, Bernie Madoff admitted to his sons that his business was an utter fraud. They told the authorities. The FBI started inspections and found out that the firm had not conducted a single transaction since its founding and was, in fact, a Ponzi scheme. Old depositors profited from the investments of new depositors, which went on unnoticed for 45 years.
The company was about $50 billion in debt. Madoff was sentenced to 150 years in prison.
Fact #5: There Was an Ant Farming Ponzi Scheme
In 1999, Wang Feng from China started a company called Yilishen Tianxi that sold ants. He offered customers to buy an ant farm for $1,500, take care of it for 14 months, and then sell it back for $1,950. The company allegedly made expensive medicines from insects.
Profound feeding instructions, a moderate profit of 30% per annum, and the actual production of pills from ants made the scam more convincing. In 2007, however, the money flow dried up, and Wang Feng delayed payments of $600 million. Some 10,000 farm owners came out in protests, which threatened to disrupt the 2008 Beijing Olympics. Chinese police eventually arrested 55 of the company’s employees. The government promised to compensate but never actually kept its promise.
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