What is a Ponzi, and moreover, what it a Ponzi scheme? As defined by Merriam Webster, a “Ponzi Scheme” is an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks (“Ponzi Scheme”, n.d.). Essentially, the money collected from newer victims (investors) of the fraud is paid to earlier victims to provide a veneer of legitimacy (“The math of Ponzi Schemes”, n.d.). Charles Ponzi (Figure 1), born in 1882 emigrated from Italy in 1903 to the United States. In 1918, after being convicted and serving time for a number of petty crimes, Ponzi developed his notorious investment scheme. Basically, investors would be lured into investing in some fictitious security and paid returns with the money of the newer investor. Hence, the Ponzi scheme was born and the reason why his name is associated with the fraudulent activity. Incredibly, Ponzi was able to convince approximately fourteen hundred investors to give him seven million dollars with the promise of fifty percent returns in 45 days and 100% in 90 days. In 1920, Charles Ponzi was convicted of 86 counts of mail fraud and subsequently sentenced to 14 years in prison. He died in 1949, leaving us with the “Ponzi” scheme which is alive and well today (“Charles Ponzi”, n.d.). Under the weight of the 2008 market meltdown, a number of “Ponzi” schemes involving hundreds of millions …show more content…
Granted the scheme has technically failed, success was never mathematically viable nor financially sustainable. Similar to a marketing pyramid scheme, the scheme becomes exponentially unsustainable over time (Figure 2). To start, let’s consider the math of a “Ponzi” scheme. The mathematical formula for a “Ponzi” scheme is best represented by a first order linear differential equation (Figure 3). The difference between a differential equation and a traditional algebraic equation is that the solution to the algebraic equation is a value of set of values whereas the solution for a linear differential equation is a function or set of functions (“Linear Equation Introduction”, n.d.). If we dissect the equation, we assume that the fund starts at time t=0, is cash in initial deposit at time , : cash influx rate at time . The amount of cash that flows in the deposit scam in an infinitesimal time interval is , T: lock-up period (T>0). The con artist promises to return the money to the investors after a lock-up for T units of time, R: promised rate on investment (R>0). It’s called Ponzi rate (“The Math of Ponzi Schemes”, n.d.). Overwhelmed, let’s consider the financial accounting in a vacuum. Essentially, the “Ponzi” organization is selling you a share of stock in their firm with guaranteed growth and dividends. If we consider the income