Fraud is as old as the human race. The Ponzi scheme is no exception: although it got its name from the infamous swindler Charles Ponzi who was arrested in 1920, he was far from the first conman to take advantage of people’s naivete this way.
But to understand the background of the Ponzi scheme, we first need to understand its definition. According to Wikipedia, a Ponzi scheme is a type of fraud that lures people in by paying out old investors using the money from newcomers, while claiming that the profits come from a business venture. As long as new investors are flocking to the “project” the illusion can be maintained; as soon as they stop arriving, it all comes tumbling down.
1870s: Adele Spitzeder
Adele Spitzeder was a German actress, singer, and con artist, who ran what is most likely the earliest recorded case of a Ponzi scheme. When her success in acting began to dwindle, she decided to open a private bank called the Spitzedersche Privatbank. To maintain her luxurious lifestyle, she would borrow money from people and promise to pay them back with 10% interest after a few months, and she would stay true to her word—by paying them back using money borrowed from other lenders. Some farmers even sold their farms to live off interest alone.
However, she claimed absolutely no business model, never explaining where the returns would come from, but that did not deter people from trusting her. Authorities brought her to trial in 1872, when she was sentenced to three years in prison, while her “customers,” around 32,000 people, lost 38 million gulden (around $470 million), which led to a wave of suicides.
1870s-1880s: Sarah Howe
Sarah Howe opened the Ladies’ Deposit Company, a savings bank that only accepted deposits from unmarried women, sometime before April 1879, claiming that the bank was working with the Quaker charity to help women of modest means through high interest rates, namely a monthly 8%. Again relying on new deposits to pay off old investors, even though she never advertised the bank, she accepted around $500,000 before she was caught in September 1880 thanks to the Boston Daily Advertiser newspaper, which claimed that she was running a fraudulent business.
A three-year-long prison sentence did little to turn her away from this type of endeavor: she set up another bank, the Women’s Bank, under the same pretenses and was again exposed in 1887. She ran several other Ponzi schemes throughout the United States, with little success.
1919: Charles Ponzi
The most famous case of a Ponzi scheme was the one that gave it the name. It wasn’t the first scam run by Charles Ponzi, who spent a total of five years behind bars before even attempting this venture. He got his idea when he received a letter from Spain containing an IRC, or international reply coupon, which let the recipient exchange it for a number of priority airmail postage stamps from another country. He decided to buy IRCs in one country and exchange them for a profit in another, which made him a profit upwards of 400% in some instances.
However, the actual Ponzi scheme started when he decided to drag in more people into this “business venture.” He promised returns of 50% in 45 days, or 100% in 90 days. He was extremely successful, reportedly making $250,000 a day at one point, but he was paying off old investors with money from new investors. However, in August 1920, The Boston Post newspaper began to investigate his returns, which set off a run on his company. He was arrested and charged with 86 counts of mail fraud, which caused him to spend 14 years in prison. The amount of press coverage, both within the US and internationally, during both its perpetration and after its collapse led to the scheme being named after him.
2008: Bernard Madoff
One of the most recent instances of a massive Ponzi scheme—specifically, the biggest one the world has ever seen—was perpetrated by Bernard Madoff, former non-executive chairman of the NASDAQ stock market. Estimates put the worth of the fraud around $64.8 billion as of November 2008. He is currently serving a federal prison sentence with a pseudo-release date of January 4th, 2137.
He started his firm as a penny stock trader in 1960. It later functioned as a third market provider, meaning it allowed institutional investors to trade exchange-listed securities over the counter instead of through an exchange. At one point, it was the largest market maker at the NASDAQ. But the focus of the fraud investigation was its wealth management arm, which wasn’t nearly as publicized as the rest of their services.
He claimed to generate returns that were large but not outlandish through a strategy called the split-strike conversion, which is sometimes called a collar and promises low risk returns. Even though this is a legitimate, legal trading strategy, Madoff actually just funneled client funds into one bank account, from which he paid out the investors who wanted to cash out, never actually investing the money the way he promised. In the end, he confessed to his sons (who he claims were unaware of the scam before that, despite working at his firm), who turned him in the very next day.
The only reason he got away with it for so long is because he generated returns high enough to make his clients look the other way, even if they were suspecting foul play. The funds were deposited in an account at Chase Manhattan Bank (now merged into JPMorgan Chase), which also had no incentive to inquire into the source of his money, as it may have made as much as $483 million from those deposits, according to estimates. His image relied heavily on exclusivity, turning prospective clients away the first time they contacted him, but also on generosity and respectability.
The best-known instance of a Ponzi in the cryptocurrency space must surely be the case of Bitconnect, which was released in 2016, claiming to let users lend the value of the Bitconnect coin (BCC) in return for interest payments. Those payments were supposedly determined by a trading bot. On January 3rd, 2018, the Texas State Securities Board sent them a cease and desist and called them a Ponzi scheme.
At one point, Bitconnect had a market cap of over $2.6 billion, with a single BCC going for more than $400. They promised a return of up to 40% a month, which is much higher than any previous successful Ponzi scheme claimed. Their aggressive marketing strategy, which used YouTube “influencers” and other known figures in the cryptocurrency space to promote the project, coupled with the FOMO (Fear of Missing Out) in the space at the time, led to its boom in popularity. Those influencers were also the first ones to deny any involvement with the project once authorities started getting involved, many of them either deleting videos and tweets endorsing Bitconnect, or outright deleting YouTube accounts and pretending they never existed.
On January 17th, 2018, the platform shut down and the price crashed 92% immediately after. Since Bitconnect as an entity never existed, it is still unclear whether they had any assets, meaning that even estimating the amount the still-unknown founders made away with is impossible. However, the vast majority of cryptocurrency enthusiasts who did not believe in Bitconnect at all had very little sympathy for the investors who lost money to the scam, and the only thing that still remains is the famous “BITCONNEEEEECT!” meme.