Lesson 8.5 · 5 of 6 · How to avoid investment scams
What is a Ponzi scheme? Madoff and BitConnect explained
A Ponzi scheme pays “returns” to earlier investors out of money from newer ones, with no real investment behind it. It survives only while more money comes in than goes out. Madoff and BitConnect both collapsed once the new money stopped arriving.
Terms in this lesson
- Bitcoin
- The first cryptocurrency, with a fixed maximum of 21 million coins.
- Staking
- You lock up crypto to help a network run and get rewards for it.
- Investor compensation scheme
- The protection that returns your cash and shares, up to a limit, if your broker goes bankrupt.
Opening question
In a Ponzi scheme, where does the money paid to the first investors come from?
That is the SEC’s definition of a Ponzi scheme: existing investors are paid with money collected from new ones. The payments to early investors are real, and they are exactly what advertises the scheme.
It does not matter if you get it wrong: trying first helps you remember.
How a Ponzi scheme works
Definition
What is a Ponzi scheme?
A fraud that pays existing investors with money from new investors.
It is named after Charles Ponzi, who took money from thousands of people in the 1920s with a postage stamp speculation scheme. The real investment is missing or tiny. The scheme runs while new money flows in; when it slows, or many people ask for their money at once, it collapses.
- Promises high, safe returnsa “secret formula”, a “trading bot”
- Pays the first investorswith money from those who follow
- Word spreadsmore and more people join
- New money runs shortpayments stop, the scheme collapses
Work it out
A scheme promises to double your money in 3 months. Ten people put in £1,000 each. How much must the scheme pay them in 3 months’ time, in pounds?
A hint
Each person expects twice what they paid in.
10 × £1,000 × 2 = £20,000. Only £10,000 of it is their own money. The other £10,000 has to come from at least 10 new people, who will expect £20,000 themselves three months later. That is why every Ponzi scheme eventually runs out of money.
Bernie Madoff’s Ponzi scheme: how it worked
Real case
How did Madoff fool wealthy investors and banks?
With moderate but always positive returns, year after year.
Bernard Madoff was a respected name on Wall Street. Clients received statements showing steady gains, with hardly a losing month, but his firm was not actually buying shares for them. In December 2008, as clients rushed to withdraw during the financial crisis, he confessed the fraud to his sons. He was sentenced to 150 years in prison and died there in April 2021.
Spot the mistake
What should worry you about this claim?
“Our fund has made money every single month for the past 10 years, without one losing month. That proves the risk is zero.”
How sure are you?
Real markets have good months and bad months. Returns that are “too smooth”, whatever the market does, were Madoff’s hallmark. And no investment that beats a savings account comes with zero risk.
Check yourself
Why did Madoff’s scheme fall apart in December 2008?
This exercise is in the free account, where we also save your progress.
Create a free accountCrypto Ponzi schemes: the BitConnect case
Real case
What did BitConnect promise?
Up to 40% a month, from a “trading bot”.
From 2017 to January 2018, BitConnect raised money for a “lending programme”: you bought its coin, BCC, with bitcoin and “lent” it back to the platform. The website showed an average return of around 1% a day. People who brought in new investors earned commissions of up to 7%. On 16 January 2018 the programme closed and BCC’s quoted price fell 92%. The SEC says the scheme took in around $2 billion from investors.
Check yourself
BitConnect showed an average return of 1% a day. What would that be over a year, compounded?
This exercise is in the free account, where we also save your progress.
Create a free accountWhat would you do?
A colleague suggests a “staking programme” that pays 2% a week and gives you 5% of whatever the people you bring in deposit. What do you do?
This exercise is in the free account, where we also save your progress.
Create a free accountWhat you learned
- A Ponzi scheme pays old investors with new investors’ money and collapses when the new money dries up.
- Madoff and BitConnect shared the same signs: high or suspiciously steady returns and a secret “method”.
- Commission for recruiting and ever harder withdrawals are signals to stop.
You reached the end
Keep what you learned
With a free account we remember your lessons, bring back the questions you got wrong exactly when you need them and keep your streak.
Save your progress with a free accountLessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: SEC Investor.gov, Ponzi scheme definition and red flags; Madoff: Insurance Journal (2 January 2025) and the SIPA trustee’s website (madofftrustee.com); BitConnect: SEC complaint (1 September 2021) and US Department of Justice indictment (25 February 2022).