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If you have been around the business world for a while, you have probably heard the term Ponzi model or Ponzi scheme. The very utterance of this phrase sends a frisson of fear down the spines of investors, many of whom have invested at one time or another in a scheme about which they suspected the worst. In this post we share the red flags to help you avoid Ponzi schemes.
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A Sordid History
Ponzi schemes are named after Charles Ponzi, who originated the first of these fraudulent schemes in 1919. Also known as a pyramid scheme, a Ponzi scheme is a scam investment opportunity. It promises investors handsome returns with little risk.
However, only the earliest investors rake in the big bucks. Later investors swell the base of the pyramid, shrinking those “handsome returns” by the hour, through the very course of its operation. Eventually, the Ponzi scheme collapses under the pressure of its own weight. The crumbling of the Ponzi structure comes at a great cost to those later investors, who lose their entire investments.
The Structure of the Ponzi Model
The Ponzi model generally has its own directors or operators who come up with the idea. First, they need some startup funds, so they attempt to attract more investors into the game. To do this, they come up with a dummy business idea. However, there is usually no business at all. If there is an actual business, though, it never produces the returns they promise.
To kick start their scam, the founders pitch their idea to potential investors. To these folks, they promise quick returns on their initial investments within a short time and with minimal risk. The naive and uninitiated are quick to take the bait.
Using their startup capital or some other funds, the fraudulent company soon repays its first investors. This they do quickly, showing off their prowess. This is the key to their success.
Those early investors become enthusiastic supporters of the burgeoning scheme. They rush to refer their associates and friends and bring them into the fold. This second layer of investors gets paid with money from other incoming investors. This creates a flowing chain in web-like fashion, but the structure quickly assumes a pyramid shape.
Ultimately, the number of incoming investors drops off. This rapidly translates into a drop in funds and the scheme falls apart.
The Ponzi Model in Forex Trading
The Forex market is not spared the Ponzi model. In fact, it is one of the fields where the model has become entrenched.
For example, in the Forex market you’ll often encounter promises of favorable returns that seem too good to be true. A broker might even promise bonuses for referrals in addition to great returns.
If you look closely, however, this Forex model will probably appear to be faulty, lacking a proper organizational structure. So look out for such models and stay safe. Avoid losing your hard-earned cash.
As a trader, you can avoid such scams by being conversant with the basics of Forex trading. Learn all you can, even before you open an online trading account. Carefully read the terms and conditions that govern any Forex broker. Ensure your broker is licensed to stay on the safe side.
How to Know If Your Forex Broker Is Operating a Ponzi Model
It can be difficult to differentiate between a legitimate broker and a broker who is operating a Ponzi scheme. However, there are few signs that can raise the alarm. Here are some red flags you can watch for to avoid this financial trap.
- Lack of a proper business organization
- Unrealistic promises of continuously handsome returns as part of their marketing strategy
- Lack of any formal licensing or permits from the proper regulatory bodies
- Little or no clarity about their trading conditions
Some advocates of Ponzi schemes suggest that once you get in one, however inadvertently, you need to make the most of it. They say you should invest heavily and get your returns before the fraud falls apart.
However, due to these schemes’ unpredictability, it is hard to get the timing right. Therefore, it is probably better to stay away from such models if you want to protect your investments—and your integrity.