If you welcome a clown, expect a circus!
No one alive is older than pyramid and Ponzi schemes, yet we still fall prey to them. We all know someone who has, if not lost all their fortune, at least been bitten by it. What is it about these schemes that are so enticing that we can't get enough? Or are we under the spell of great sorcerers, disguised under well-manicured suits, with silver tongues? Whatever it is, we have proven that since we have fallen for them so many times before, we are more than likely to do it again.
Robbing Peter to pay Paul. We all know this trick but still. Sometimes I get to a point where I don’t feel bad anymore if someone gets caught up in these schemes. Like, if you did not see that coming then, well maybe you are the one to blame really. Your money is of better use in their hands at this point.
However, I recently realised that some are getting smart that even the most educated minds do fall for this. This is because the classic Old Man’s Ponzi scheme has changed a lot over the years. This particularly shocked me because, as per my reasoning above, I could easily be the fool I described.
I shall try and explain this as easily as I can.
The Old Man’s Ponzi
I have no legitimate product to offer you, but I’m good with words and can amass 10 people to give me 1 million to invest in a once in a lifetime opportunity that will double their investment. They give me 3 months to pay them back. After 1 month I get another 10 people to give me the same amount for the same period. Now In another month, I do the same gimmick. Now I have enough money to pay the 1st lot their money plus interest.
At this point, 2 things can happen. You pay the first lot and they go on their way or You pay the first lot and given the joy of doubling their money, they decide to stay with you. The highest probability is that they will be high on the thrill of making such an “intelligent” decision that they will most definitely want more.
Given this turn of events, you continue with the cycle. At a certain point, you will have more money coming in than is leaving out so you can be able to sustain the model. You can even start dipping in the honey pot. Why not reward yourself for your tireless efforts.
The investors are hooked. This leaves the schemer 2 options. To pack up and disappear with everyone's money? Or to continue and see how far this will go. Remember greed? Option 2 it is. The problem with this is that our economy is not so grand and recessions do happen. This is the point where withdrawals start overtaking deposits and eventually poor old schemer cant pay back and he is exposed for what he truly is.
In this type of Ponzi the winners are only 2. The initial investors who invested and withdrew early. And the schemer, if he disappeared with the money early enough. Well, the losers are the late investors and the greedy ones who decide to stick for the ride.
The Modern Ponzi
The modern Ponzi is a bit more challenging to spot early on. The schemer does have a product and a mighty good one at such. The schemer presents the product as an opportunity for the investor to acheve an attractive return, but not so high to raise suspicion. The product is well presented to the investors and they do see the value. At the onset, everything is okay and no red flags can be raised as all the checkboxes for a good investment are ticked. Let's say the return is 10%.
Investors start to invest with the schemer. Now, this is what happens. The product does not return the 10% as the schemers informed the investors but returns a mere 5%. This is not so bad as the investors are not losing money, they are just not getting the return they were promised. True. But that is not all.
The schemer will not admit this underperformance of the investment but will pay the initial investors 10% interest. Where does the additional 5% come from? Well, you guessed it Paul’s 5% will come from Peters money. Now the scheme has entered into the same scenario as the Old Man’s Ponzi, but not as blatant as the schemer did not promise to double your money.
So how does the schemer benefit? Why not admit the underperformance and pay 5%. This is a very good question with a very simple answer. Fees. The schemer collects fees by managing the investors' money. So the longer investors stay in the investment the more fees they can collect.
Such schemes take longer, even decades before they collapse, due to the small leakage of investor funds. They also tend to fail or struggle during recessions, where they witness mass withdrawals and underperformance of their assets.
The Future Ponzi
Innovation creates the best inventions that drive mankind into more prosperity through speeding up processes, fostering efficiency and introducing novelty. However, it can also create new ways of promoting crime and other vices. I’m certain we shall see other ways in which the concept can be manipulated to transfer wealth, but I’m also sure we shall have ways to get on top of them even sooner.
In a world fuelled by capitalism, what happens when you mix greedy educated men, with a gold-rush crazed society? You get what you deserve!
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