The name 'Ponzi scheme' comes from Charles Ponzi, who designed one in 1885. In this scheme, the person organizing the scam promises high returns to initial investors in exchange for new investors. The organizers then use the money they collect from new investors to pay off the original ones. This way, the organizers of the scheme end up with more money than they originally collected. Since no actual work went into starting the scheme, people have a good reason to be suspicious of these ventures.
Ponzi first came up with his idea when he saw that a friend had run away with money he had paid him in Italian gold coins. Ponzi realized that some people would be willing to exchange their money for something that others had. With this realization, Ponzi came up with his scheme: he would organize a company with initial investors and then recruits new investors. In exchange for investing the new investors would receive weekly returns- which is how the name 'Ponzi scheme' came about. Of course, there were already scams like this going on at the time, but Ponzsi's idea was unique in that it used an organized group to run its operations.
As Ponzi realized his idea, he quickly set up a business in Como, Italy. He hired teenagers and young adults as salesmen for his venture and gave them envelopes with money and instructions to recruit new investors. Although Ponzi had originally planned to divide his profit between himself and the original clients, he ended up keeping all of the proceeds from his sales. By failing to divide his profits between old and new investors, Ponzsi ended up making far more money than he had originally planned. In this way, he became one of the first pyramid schemes.
To make sure that his investors got what they paid for, Ponzsi promised high returns on their investments. He claimed that his investment plan had a 100% success rate and promised weekly returns on each client's investment. Since there was no way for clients to know if Ponzsi's plan was actually successful or not, they agreed to invest and shared in his profits. As time went on and more people bought into Ponzsi's plan, it became much easier to pull off fraudulent operations thanks to organized groups like this one.
Since Charles Ponzi was an innovator of a scam before anyone had even heard of 'pyramid scheme,' many people think that he came up with the name himself. The name 'Ponzi scheme' comes from Charles Ponzi since it is based on the same scheme- but targeting different groups of people. The word 'ponzi' is an Italian word meaning 'trick' or 'cheat.' Since many different scams use organized groups to pull off their operations, these names make perfect sense since 'organized groups can cheat us out of our money as easily as Charles Ponzis did.'
In 1983, the Securities and Exchange Commission (SEC) used 'Ponzi scheme' to define fraudulent investments in their guidelines for stock brokers and brokerage firms. The SEC defined a Ponzi as an investment contract that offers unreasonably high returns with no chance of compensation to initial participants or beneficiaries. Additionally, organizers never actually invest anything into the scheme- which is how they are able to receive payments from subsequent participants within weeks of initiating new investments into the plan.
Based on what we know about Charles Ponzi today, it seems that he was a charming man who liked making promises he couldn't keep- even if it meant defrauding people out of their money. Since many have tried - and failed - to copy his formula for success, it seems unlikely that anyone will ever come up with something as profitable as a pyramid scheme again.
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