How the Ponzi scheme works and what risks it poses to investors

Ponzi schemes are one of the oldest and most dangerous financial scams, deceiving millions of people worldwide for decades. The name comes from Charles Ponzi, who in the 1920s became famous for using this method in Boston. Although over a hundred years have passed since then, the mechanism still works almost identically today, especially in the digital asset sector.

Origins of Ponzi Schemes – Lessons from the Past

The history of Ponzi schemes dates back to when Charles Ponzi promised investors 50% returns within 90 days through investments in international postal coupons. This promise was unrealistic but attracted thousands of people who saw a chance to get rich quickly. Interestingly, the system did pay out for a while— but the money came solely from new investors’ contributions, not from real business profits.

A classic Ponzi scheme operates on a fundamental paradox: it functions like a traditional investment but does not generate any real income. Instead, it recruits more and more new investors, whose contributions go to the pockets of earlier participants.

How the Scam Works: How Pyramid Schemes Start and Collapse

The structure of Ponzi schemes resembles a house of cards. At the top sits the organizer, promising extraordinary investment returns— often 20-50% annually, while safe financial instruments offer 3-8%. Below are the first investors, who actually receive the promised profits, creating the illusion of legitimacy.

The lower you go in the pyramid, the greater the risk. The last participants, who keep entering the system, will never get their money back. When the number of new investors decreases— which must happen because everyone has limited financial resources— the system begins to shake. When the demand for new participants drops below the break-even point or when many investors demand withdrawals, the pyramid inevitably collapses.

Madoff and Modern Frauds: Cases That Should Teach Us Caution

One of the biggest lessons about Ponzi schemes was the Bernie Madoff case. In 2008, the financial world was shaken by the news that one of America’s most prominent investment managers had run a massive Ponzi scheme for decades. Madoff’s fraud swallowed about $65 billion— funds not only from wealthy investors but also from pensions, charitable foundations, and individuals saving for retirement.

What’s particularly shocking is that Madoff operated openly, with an office in a prestigious Wall Street location and working in the industry for decades. His case shows that even regulatory oversight can fail, and trust in reputation can be a blind alley for investors. It always requires especially careful scrutiny and questions about sources of profits.

New Horizons of Risk: Cryptocurrencies and Fraudulent Investment Platforms

In recent years, Ponzi schemes have moved into the world of cryptocurrencies. Digital currencies have created ideal conditions for scammers: fast transactions, anonymity, lack of central regulation, and young, less experienced investor groups seeking quick profits.

Many investment platforms promise incredible returns from “mining” cryptocurrencies or “passive income” through staking. In reality, many of these platforms operate exactly like Ponzi schemes—they take money from new users and distribute it as “profits” to earlier participants. When the number of new users dries up, these platforms disappear overnight with billions of dollars that investors trusted them with.

Seven Warnings: How to Recognize a Ponzi Scheme Before You Become a Victim

Identifying Ponzi schemes requires familiarity with several red flags that almost always appear:

1. Unusually consistent returns – If an investment promises 30-50% returns annually with minimal risk, ask what it’s based on. No legitimate business generates such consistent returns.

2. Lack of a clear business model – Organizers cannot clearly explain how money actually generates profits. They respond with vague answers or change the subject.

3. Pressure to recruit – The system encourages inviting friends and family. The more people you recruit, the better for you— this is a classic pyramid signal.

4. Difficulty withdrawing funds – Although profits are easily accessible, withdrawing the main capital is cautiously restricted, with conditions or limitations.

5. No regulation or license – Legitimate investment platforms are always regulated. If you cannot verify a license with a financial authority, avoid it.

6. Promises of guarantees – No one can guarantee investment returns. Any promise of “guaranteed profit” is a scam.

7. Time pressure – Phrases like “You must join now before it’s too late” or “The next 100 spots are already taken” are typical tactics creating urgency and prompting hasty decisions.

The Role of Regulators and Education in Combating Financial Pyramids

Regulatory bodies worldwide are increasingly active in fighting Ponzi schemes. The SEC in the United States, FCA in the UK, and similar agencies in other countries conduct investigations, issue warnings, and arrest scammers.

However, education remains the best defense. Investors who understand how Ponzi schemes operate can recognize and avoid them. Central banks and financial institutions are increasingly publishing guides for citizens, but ultimately, the responsibility lies with individual investors— asking critical questions and researching before investing their money.

Conclusions: Why Do Ponzi Schemes Remain Relevant?

Ponzi schemes have survived over a century because they rely on a fundamental human weakness— the desire for quick wealth. As long as people seek ways to get rich without effort, scammers will develop new variants of these frauds.

Understanding how Ponzi schemes work is crucial for anyone looking to invest their money. The history from Charles Ponzi to Bernie Madoff and modern crypto scams shows that whenever something seems too good to be true, it almost always is a scam. Vigilance, knowledge, and skepticism toward impossible promises are the best tools to protect yourself from falling into a Ponzi trap.