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A Ponzi scheme is a common type of scam in which “investors” who had previously invested in a company are given funds from new “investors.” However, there is no real viable business model.
Be wary of those who offer suspiciously high returns or invite you to join an exclusive “crypto investment scheme.”
Have you been a victim of fraud? Immediately report the incident to law enforcement and Binance support.
In our new episode, How to Recognize a Scam, you'll learn about Ponzi schemes in the crypto industry and how to recognize and avoid them.
What is a Cryptocurrency Ponzi Scheme?
Imagine that someone offers you to earn a fortune in a short time, without risking anything: just a small investment is enough. In addition to this, you have been asked to tell as many people as possible about this.
These are signs of a Ponzi scheme, a common type of scam in which “investors” who invested in a company previously are given funds from new “investors.” Ponzi schemes exist across a variety of industries and can arise in any environment where investment activity is possible. Unfortunately, scams like this are widespread in the world of cryptocurrencies.
In this article, we'll look at how cryptocurrency Ponzi schemes typically unfold and what you can do to protect yourself from them.
How does a Ponzi scheme work?
In most Ponzi schemes, there is no real investment and almost all the profits go to the scammer. The money of new victims is transferred to earlier participants. This redistribution of funds creates the appearance of profitability, which maintains the existence of the scam.
As long as there is a sufficient influx of new participants, the financial fraud continues. As soon as there are no more victims, the scheme comes to an end and it collapses.
Here is a detailed description of the three typical stages of a Ponzi scheme.
Step 1: Create an Attractive Layout
The Ponzi scheme is one of the oldest classic scams. It originated in the early 1920s in North America when Charles Ponzi, an Italian immigrant, promised investors a 40% return in just three months.
Charles's scam was simple: pay yesterday's investors using today's money and pocket the remaining profits. Its promise of 40 percent returns continued to attract unsuspecting victims and amassed more than 30,000 such investors in less than six months.
Charles was arrested after his scam eventually collapsed, depriving his "investors" of about $20 million (about $207 million today when adjusted for inflation). By comparison, Bernie Madoff's similar company collapsed in 2008, costing his "investors" about $18 billion. This case is often called the largest Ponzi scheme in history.
Step 2: Reward investors who invested early.
In a Ponzi scheme, early investors are deliberately paid a promised return, causing them to believe the scam works and encourage their friends to invest in it.
It is also quite common these days to see Ponzi schemes offering additional rewards or bonuses to those who successfully attract new investors. In some cases, “investors” are required to attract new investors if they want to continue to receive money. This technique allows attackers to find new victims with minimal effort.
Sometimes attackers create complex reward structures. Then the “investors” or “employees” have to attract new victims in order to receive funds. Such schemes are often called financial pyramids.
Step 3: Collapse
Eventually the house of cards is doomed to collapse.
Typically, scammers have a plan to disappear, which they carry out when profits reach a certain level or when the scheme is about to fall apart. While a small number of investors may actually make a profit, the vast majority will lose their entire investment and be left with nothing.
To help users identify Ponzi schemes in the cryptocurrency world, the Binance risk management team has developed the following formula based on analysis of many real-life situations:
Invitation + promise of suspiciously high income + guaranteed profit + reward for referrals = Ponzi scheme
Example of a cryptocurrency Ponzi scheme
A user, such as Lily, invests in a crypto investment fund that initially generates a 10% return. However, the scammer says that if Lily wants to continue making money, she must attract new investors.
The scammer promises Lily a 15% reward for every ten clients she invites. If new clients continue to refer people, Lily will receive 7% as a second level reward, and so on.
Lily realizes it's a Ponzi scheme only after it collapses and she loses all her funds.
Tips for protecting yourself from Ponzi schemes
Recognizing a Ponzi scheme can be difficult, but here are some common signs to look out for.
Be wary of high-yield cryptocurrency offers or “schemes” that lock up your money under arbitrary, confusing terms. Remember, as a general rule, always do your due diligence before making any investment decisions.
Consider all investment opportunities that promise guaranteed high returns as a potential scam. Typically, there is a trade-off between risk and reward: any investment that promises both an attractive return and a 100% guarantee is highly suspect.
Be wary of invitations to join “investment teams,” especially if they offer unrealistically high returns.
Request official documents according to which the crypto investment “plan” or “scheme” is planned to be implemented. If you are told that an investment strategy is confidential or too complicated to explain, you are most likely dealing with a scammer.
Always ask yourself how the “scheme” makes a profit for its investors. Be careful if it uses a technique you've never heard of before.
What to do if you are a victim of a cryptocurrency Ponzi scheme
Here are some steps you can take to minimize the damage if you fall for a Ponzi scheme.
If you have provided sensitive information, change your passwords and immediately freeze your bank and any other compromised financial accounts.
Report the incident to local law enforcement. Binance works closely with law enforcement, and this regularly results in the discovery and seizure of assets. While getting your money back is by no means guaranteed, in most cases it is the only option available.
Report the incident to the moderators of the site, application or social network through which the fraudster contacted you. Provide his profile name and any information that might protect other users.
Be wary of offers of “refund services.” Although sometimes you may be offered real help, often these are just false promises or advance payment scams. Don't fall for another trick.
We also encourage all users, new and old, to review our Anti-Crypto Fraud Series to help protect yourself from common threats.
Additional Information
How to Recognize a Scam: A Complete Guide to Identifying the Most Common Cryptocurrency Scams
How to Recognize a Scam: How to Protect yourself from Imposter Scammers on Binance
How to Recognize a Scam: Crypto Investment Scams to Watch Out for
How to recognize fraud: protection against scams related to the distribution of cryptocurrency
Risk Warning and Disclaimer: The following materials are provided “as is” without warranty of any kind for general reference and educational purposes only. This information should not be considered financial advice or a recommendation to purchase any specific product or service. The value of digital assets can be volatile. The value of the funds invested may go up and down. You may not get your invested funds back. You are solely responsible for your investment decisions. Binance is not responsible for your possible losses. This information does not constitute financial advice. For more information, please review our Terms of Use and Risk Disclosure.