Ponzi schemes are named for Charles Ponzi, Italian immigrant turned small time crook, turned big time crook. A product of the American post World War I boom, Ponzi was arrested in 1920 in Boston.
Ponzi scemes are relatively simple. The archetect of the scheme convinces a group of investors to invest with him, usualy by enticing the potential clients with promissed returns on their investments that are far outside of the norm. Greed overwelms common sense and so people hand over their money.
People begin to pile into the scheme and soon recieve the promised returns. This is vital. In order to keep the system going the schemer must pay these initial investors. This creates credibility and so more investors join in.
The key to a Ponzi scheme is the constant influx of new investors. The initial investors are paid with the new money rolling in, and so on, and so on.
The whole thing works pretty well until something changes and new investors can’t be found.
Like most things in economics and finance, a Ponzi scheme can be illustrated using an example from nature.
A Ponzi scheme is similar to a lake with one river coming in, (money from new investors) and a river flowing out. (Distributions to established investors.) If the money from the new investors stops flowing in, the money soon stops flowing out, and the lake (the scheme) dries up.
The essence of a Ponzi scheme is greed.
Ponzi schemes are doomed from the moment they are concieved. Likewise so are the investors, and more often than not, the perpetrator.