Chrales Ponzi was an immigrant to the USA. He launched an investment scheme in 1919 in the city of Boston, promising to double the money in 90 days. At its peak, the scheme had 40,000 investors who had invested around $15 million in the scheme. The scheme collapsed a year later on August 10, 1920. It was revealed that Ponzi was using the money invested by the new investors to pay off his old investors.

All Ponzi schemes are zero sum games, where money gained by the early investors is equal to the money lost by the latter investors. And the most vulnerable investors are those who come at the end.

Business Model of Ponzi Schemes

Ponzi started a business magazine. He made an offer to a person in Spain to subscribe to this magazine. The person sent him an international reply coupon, which could be exchanged for American stamps at the local post office. The stamps could be used on the parcel of magazine sent. Ponzi realised that the coupon in Spain cost the equivalent of one cent in the American currency. It could be exchanged for stamps worth six cents. It was a riskless profit of 500 per cent. Ponzi realised the idea worked for other countries too.

He built an investment scheme around this idea.He could raise money. The money can be converted into foriegn currency, which could be used to buy international reply coupons. These coupons can brought back to America, and could be converted into stamps. These stamps could be sold for huge profits. It is an arbitrage opportunity.

The whole operation is complex. There are problems of dealing with the postal organisations. There are problems of currency conversion and transfer.

The legitimacy of the scheme was questioned by the Boston Times. It was revealed only two stamps were purchased. Ponzi was using the money of the new investors to pay off the old investors.

Any Ponzi  scheme can keep running till the money entering the scheme is more than the money leaving the scheme.

Today when gullible investors are given promises of excessively high returns and then at one stage ditched and disappointed, the media uses the word that they are running a Ponzi Scheme.