Posted in Science & Nature

Airplane Game

You are cordially invited to a game that lets you earn money very easily. The game works like this:

  1. You pay $1000 to be recruited as a passenger to a plane.
  2. There are 8 passengers, managed by 4 crew members, who have 2 co-pilots above them, co-ordinated by a captain at the top.
  3. Everytime the “plane” is filled with 8 passengers, the captain retires and is paid out $8000.
  4. When the captain retires, the plane is split into two planes and everyone else is promoted one step higher (co-pilots each become a captain, crew become co-pilots, passengers become co-pilots).
  5. When each plane fills with 8 new patients, the captain of each plane gets paid out $8000 and retires.

This seems like a very easy way to earn money. Where else could you invest money and guarantee a 700% return, only needing to recruit 7 new people into the game?

The problem with the airplane game is that it is a classic example of a pyramid scheme. At first glance, it seems that the payout of $8000 is guaranteed because it seems that the promotions will keep coming.

But if you look at the mathematics, 8 people need to participate before the first player wins. 16 people have to participate for the second player to win. 80 people have to participate for the tenth person to win. If you are the one-thousandth person to join the game, you need a total number of 8000 people to be playing the game before you are paid out. At the end of the game, 87.5% of people playing will have lost money because they will never be paid out.

This is how simple exponential growth can result in a very real fraud, resulting in thousands of people losing their hard-earned money.

Posted in History & Literature

Ponzi Scheme

Money is a human invention that acts as a medium of exchange and a store of value. It lets us easily carry around our assets in the form of paper, or nowadays, on a card. But because of its characteristics, money allows for some very intricate, complicated con schemes. One famous example is the Ponzi scheme – a type of investment scam.

In 1920, Charles Ponzi had a great idea. Back then, people would send an international reply coupon along with international mail so the receiver could send a reply using the coupon. Ponzi noted that since the value of these coupons were constant across nations, buying it cheap in one country then selling them in the United States would lead to profit. To kickstart his business idea, he began gathering investors, to whom he promised large returns that the investors could not refuse. However, when Ponzi began trading the coupons, he quickly found that it was not effective and he did not make the profit he expected. But instead of telling the investors that his plan failed and that they would not get the returns he promised, he decided to try something different.

Having not heard of Ponzi’s failure, new excited investors asked Ponzi to invest their savings too. Ponzi used the invested funds to pay off the original investors by redistributing the money. Happy that they got their promised returns, the original investors told their friends and family about the incredible opportunity. This brought more new investors to Ponzi, whose money he used to pay off the previous investors. Because Ponzi took a commission from each investment, he quickly raked in a massive amount of money – just by redistributing money around and not actually investing a single cent.

But Ponzi schemes do not last. Eventually, the amount of new investments were not enough to pay off the previous investors and people began investigating, only to discover that Ponzi was scamming them all along. 

The Ponzi scheme relies on three things: enticing investors with the promise of high returns, intricate redistribution of money to feed the previous group of investors and the good reputation built through word of mouth. Because the scheme relies on paying old investors with money taken from new investors, a larger number of new investors is needed compared to the old investors. This leads to the formation of a pyramid. When the number of new investors is not enough, for example during a recession, the pyramid’s base becomes weak and the whole scheme collapses, with everyone losing money except for the schemer and the few original investors.

(Click Read More for diagram explaining a Ponzi scheme)

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