You've probably heard the term Ponzi scheme before, let me write it down, and what we're going to do in this video is explain what it really is. You might have a sense it's some type of scam, that you're taking one person's money and giving it to another, but we're going to do a tangible example of how it actually works. And right here, I have two pictures of the probably the two most famous perpetrators of Ponzi schemes, this is Charles Ponzi right here. It was obviously named after him and then, more recently, this is Bernie Madoff, who pulled off probably the longest-lasting and largest Ponzi scheme of all time. Who knows, maybe there's a longer-lasting and larger one out there that we have still haven't figured out yet, but this is the largest one to date. And Ponzi wasn't the first person to come up with the Ponzi scheme, but they decided to name it after him because he was the first person to really make it famous. This mugshot was taken in the early 1900s when he was finally caught for perpetrating his scheme. So how does it work? So let's start with some investors here. We could get rid of pictures of these two gentlemen. So let's say that I've got a scheme, and what I'm going to do is I'm going to set up my investors, so these are my investors. And then, let's say, we have several time periods. So we can see why the investors think, at least initially, that my scheme is legitimate. So, let's say, that this is the time period, so we have period one, maybe this is years, year one, year two, year three, year four, year five. What I'm going to do is I'm going to write each investor-- I'm going to write down how much money they think they have with me, the person operating the Ponzi scheme and then I'll show you exactly how much money I have and how I can even get away with having the first investors think that I'm legitimate. So let's say I have investor A. So this is going to be their investor's perceived-- let me do this in a different color-- investor's perceived holdings or perceived value. And over here, I'm going to write total actual value. So you can imagine, this is the actual amount of cash that I have. So we have the investor A in blue, and let's say in year one, he gives me $10,000. And I say I I've got a surefire way of doubling his money in the second year. So in the second year, I actually do nothing with the money and you know, I might actually be spending it on my own yachts and you know, fancy suits and whatnot. But let's just say I'm just keeping it in a bank account so you know, he gives it to me,$10,000 and I do nothing with that money. I don't even get interest on it. It's not even in a bank account, I stuff it into my mattress. So the reality is, after a year, it's still only $10,000, but I promised him that I had some type of a genius scheme that could double his money in a year, so I send him a statement that says that his$10,000 is now $20,000. And I feel good about it because I know that he's going to be so excited that his money doubled that he's going to want to keep his money with me, because he'll hope that it can double again. And not only is he going to do that, but he's going to go to the country club and show off to all of his other friends how he was able to do way better than they did with their investments. So he's going to essentially convince other people to join in. So let's say he convinces investor B to join in. Investor B looks at the statement says, hey, this guy running this-- well he doesn't know it's a scheme, let's say he says , Sal seems to know what he's doing, he doubled investor A's money in a year. I'm going to give him a bunch of money, let's say I'm going to give him$15,000 in year two. So how much total actual value do I have in year two now? I have the $10,000 from investor A plus this$15,000, so I have a total of $25,000. This is the actual amount that I have in my bank account, assuming that I'm not spending it on my yacht or my fancy suits. But the total perceived value, let me write that down another line, if everyone actually wanted the amount of money that they thought they had back, I would have to pay out$35,000. But we know that's not going to happen, because people think I'm such a good investor, they want their money to ride as long as possible. So you already see this discrepancy. There's only $25,000 in this little pile of money that I'm collecting, but people think that there should be$35,000. This is their perceived value, because the this guy thought his money doubled, although it didn't, it just sat there. Now, let's say that the next year I sent them statements that say, look, I made super-awesome investments again, the money doubled again. So this guy's money, his perceived value, he gets a statement that says you now have $40,000. This guy down here, investor B, gets a statement that says you now have$30,000. And then they go back to the country club, and they get investor C onboard. They're like, look, both of us have tried out this guy, he's doubled our money two years in a row for both of us, you probably want in on this as well. And investor C is like yeah, well you know, my two buddies, they look like legitimate guys, let me put my money there. Let's say it gets bigger every time because that's usually how these things go, you know, you normally don't don't have just three investors, you'll have hundreds of investors. And the more fake positive returns you get, the more people that want to put their money in. So investor C, let's say he comes in and he puts in $20,000. So what's the reality? Let's focus on it. So there's a perception on year 3, this guy just put his$20,000. A think he's got $40,000, B thinks he has$30,000, so the perceived value here's $40,000 plus$30,000, $70,000 plus$20,000 is $90,000. That's the perceived value. But the actual value is just going to be this$25,000 we had in period two, assuming we didn't spend the money or do anything with it plus the $20,000 that this guy just deposited. So the reality is$45,000. Now let's say that as we go from period three to period four, or let's say right when this guy gets his statement for $40,000, and it's the exact same time period that this guy had put in his$20,000. Let's say person A, he says, you know what, I felt like my ride has gone long enough, I don't want to test fate, let me take my money out and you might say, oh you the scheme will be ruined, but it's going to work because enough money is coming in from new investors to pay this guy off. We now have $45,000 actual value, even though the people think there's$90,000. So if this guy withdraws all of his money, so if he withdraws all of his money so it goes to zero, I have the cash to pay them. I have $40,000 even though people think there's$90,000. So I subtract out $40,000 right here, and there's only$5,000 dollars left in the bank account and since this guy withdrew his money, the perceived value-- this $40,000 is no longer there, I gave the guy the cash-- the perceived value now is$50,000. So I essentially owe people $50,000, investors B and C think that they have$50,000 invested with me, but the reality is that I only have $5,000 in my bank account. And probably a more realistic reality is I was probably spending a lot of this money on my own little luxuries the whole time. But let's continue another way, once again this guy, not only did he double his money for two years, they're all the same country club. This guy doubled his money again, this guy just invested his money. And now this guy says, look, the scheme is legitimate. This legitimized the scheme This is legit. Because, look, I doubled my money for two years and I was able to withdraw the money. So he was able to withdraw his money, so when he goes back to the country club, he gives this guy and that guy more conviction that this is all on the up and up. And then investor D will probably jump in too and say, wow, now that he's doubled money two years in a row, I see it's legitimate. Investor A was able to withdraw his money, I'll give even more money, I'll give$100,000. Maybe this is a ton of people who are now going to put in a $100,000. And then the next year, I double the money again. And obviously, I won't make it exactly double, I'll make it, you know 40% one year and 30% percent the next year so doesn't look too suspicious. I want to make it look like real returns, but for the sake of our math, let's say I double it again. So now and we're in year four. And this guy withdrew all of his money, but investor B now thinks he has$60,000. Investor C thinks he has $40,000. And investor D thinks he has$200,000. Oh, and I forgot to put investor D's deposit here. So when he put a $100,000, I only had$5,000 in my bank account, but then if I add $100,000 I'll now have$105,000 in my bank account after this guy comes in at, you know, at the end of period three, we can imagine. And, with the perceived amount, I owe is $150,000. So the green is what happens after D comes in, so these are no longer valid. But you can see that as more money comes in, I have more and more money to pay out, even though I'm not doing anything. Even though all of these returns are fake. So now I actually have$105,000 even though people think, well that's at the end of period three, at the end of period four, what do people think? People think that I have $300,000 of holdings. Let me write that down. But the reality is I still only have$105,000 of holdings. This is the total actual value. But notice, if this guy or this guy, some of the early investors, wanted to pull out some of their money, although they probably don't want to, because where else can you double your money every year and this guy already showed that I'm good for paying back the money. But even if this guy or this guy wanted to pull out their money, I would be able to give it to them because I have at least enough for those withdrawals. Now, everything would be ruined if everyone gets freaked out or scared and if I have mass withdrawals or if more people withdraw money than there is in the bank plus the amount of money that comes in. So in order for a Ponzi scheme to keep going, and Bernie Madoff was able to do this for very long time, you have to have good, believable, legitimate returns. Although they're not legitimate, they just need to look legitimate. So that you have more money coming in that out. And the whole point of the doing this Ponzi scheme, if you're a stylish criminal, isn't just to keep the cash there, you know, the \$10,000 from one period to the next. The whole point of it is to take a lot of that for yourself, for you to live off of and put into some Swiss bank account to be able to escape the country at some point. Anyway, hopefully you found that enjoyable.