The scheme is designed to convince the public to place their money into a fradulent investment. Once the scam artist feels that enough money has been collected, he disappears - taking all the money with him.
Five Key Elements of a Ponzi Scheme
- The Benefit: A promise that the investment will achieve an above normal rate of return. The rate of return is often specified. The promised rate of return has to be high enough to be worthwhile to the investor but not so high as to be unbelievable.
- The Setup: A relatively plausible explanation of how the investment can achieve these above normal rates of return. One often-used explanation is that the investor is skilled and/or has some inside information. Another possible explanation is that the investor has access to an investment opportunity not otherwise available to the general public.
- Initial Credibility: The person running the scheme needs to be believable enough to convince the initial investors to leave their money with him.
- Initial Investors Paid Off: For at least a few periods the investors need to make at least the promised rate of return - if not better.
- Communicated Successes: Other investors need to hear about the payoffs, such that their numbers grow exponentially. At the very least more money needs to be coming in than is being paid back to investors.
Steps in the Ponzi SchemePonzi Schemes are quite basic but can be extraordinarily powerful. The steps are as follows:
- Convince a few investors to place money into the investment.
- After the specified time return the investment money to the investors plus the specified interest rate or return.
- Pointing to the historical success of the investment, convince more investors to place their money into the system. Typically the vast majority of the earlier investors will return. Why would they not? The system has been providing them with great benefits.
- Repeat steps 1 through 3 a number of times. During step 2 at one of the cycles, break the pattern. Instead of returning the investment money and paying the promised return, escape with the money and start a new life.