Is This a Ponzi Scheme? Mental Model

When I was in my second year of uni, I became a victim of a phone call scam. It was the very simple and predictable scam of asking OTP and compromising an account, something that I thought I’d have known better.

It became one of the most painful experiences of my life. Not because of the IDR 700k (~50 USD) that I lost from the call, but because I was beating myself very hard for it after. I was an undergraduate majoring in computer science for goodness sake! I learned how to build an OTP system from scratch and even did group research on Two Factor Authentication in one of the courses I took. It was definitely easier to say that I was hypnotized, but I know I wasn’t.

I was just a victim of my own cognitive biases and folly.

Now is almost one year after I got out of uni and started to receive paychecks monthly. While some people are still figuring out how to save and not overspend their salary, a huge chunk of my generation are starting to figure out where to put their money to make it grow. This is something very refreshing and nice to see because more people are realizing the importance of long-term investing. However, listening to my peers talk about the investment vehicles they associate with sometimes scares me.

Knowing the pain and shame that occurs after encountering a fraud and loss of money on top of that (I ended up spending the rest of the month eating 70 cents meal every day), I feel that I need to say something. This blog post will not go deep into the intricacies of fraud, but will instead explore the mental model that I adopt when treating my money to reduce the possibility of going deep into sketchy investments and (again) falling as a victim to fraud.

Big disclaimer: I am a software engineer and not a financial expert. The views and opinions I write below are what I think and believe in when this post is written. I might be wrong, and I might change my views in the future. Reader’s own discretion is advised.

Monkey see, monkey do

Social media, I must admit, is a scary place to go around these days, especially if you’re one of the young adults who recently graduated. We’re just getting into our first full-time job, getting paid by using (and sometimes not using) our degree that we struggled to get for years for the first time. And then we scroll through our social media and we see our peers, the friends and batchmates of our class soaring high in their career and financial successes.

Some are navigating a successful journey of entrepreneurship. Some are posting pictures with their Ford GT with the caption ”hard work pays off!! 💪🏻🏎”). Some are posting pictures outside of a house they just purchased as a 23-year-old.

If it doesn’t get into your head and bombards you with internal monologues of “And here I am with my one-digit salary and still very much living in my parents’ house”, it gets scarier.

Some are sharing how they gain overnight success by investing in cryptocurrencies, and how you can join their successes as well! If you just put your money into this XXX coin. It’s going to the 🌔🚀🦍💎✊🏻 !!!

Some are sharing about a breakthrough automated approach of investing using these so-called trading robots. Make your money work while you sleep!

We’re like most people and we default to truth. When we’re exposed to the same thing over and over again, we’re prone to the Mere-exposure effect, we’ll begin to like the idea of reaching overnight successes and making big money just because we see it every day on our feeds. If a lot of people are doing it, why can’t I?

Well, I admit I’m passive-aggressively referring to certain archetypes of people and investments. However, what I’m saying is not “Do not invest or follow this kind of people”. It’s more like “If you’re on social media, or if you consume any kind of media for that matter, be aware that your outlook towards money and investments is probably influenced by the people you follow”

Mental note 1: Be aware that your outlook towards money and investments is probably influenced by the people you follow

I’m greatly influenced by a particular Youtuber I follow myself. These people might be wrong, and I might be wrong on my outlook toward money and investments by following them. However, I make sure that I am aware that my investments and spending habits are influenced by them.

It’s often too much of a trouble to do research and due diligence before going deep into something. Following the steps of other people that already reached their successes is much easier, even when the whys are not well understood. It’s the way to go for most people.

Avarice is perpetual

When reading the book Extraordinary Popular Delusions and the Madness of Crowds, I learned a new vocabulary: avaricious. It’s a fancy word for greedy, but it is also more particular to the extreme greed of wealth. I think the word matches well with another fancy word, perpetual, which means never ending or changing.

Avarice is perpetual. Human greed for wealth is never-ending.

You might be familiar with advice like these:

“Only put the money you’re ready to lose in this investment”.

“This investment is super risky, but you’ll be okay if you exit before it goes down”

But from time to time again we see informed and educated people lose a huge chunk of their wealth to the biggest of scams or pump and dump schemes. Sometimes we can’t just leave our money alone. We see 5% of our wealth growing 1000% a year while investing in this new hot coin and we can’t just leave the other 95% just gaining 8%. Unless we’re very experienced and emotionless with money, we can’t just let this big opportunity slip away.

My second point is not “Don’t be greedy”, because it’s almost similar to saying “Don’t fart while in public”. You know you’re about to do it and you’re not supposed to, but sometimes you just can’t help it. But knowing that you’re as likely to forget risks and be greedy as you’re to fart in public helps.

Mental note 2: You’re as likely to be greedy as you’re to fart in public

“Is this a Ponzi Scheme?”

Now let’s get to the juice of this post. Let me put on my lecturer hat and give you a bit of a recount in history.

In the early 1900s, there lived a guy named Charles Ponzi. He was an immigrant from Italy that moved to Boston in 1903. When he first came to America, he worked odd jobs before he found his way to become a bank teller. The bank went bankrupt and he was left penniless. On top of that, he was caught forging a bad check and went to prison. Not long after he got out of prison, he went back for a different charge of smuggling immigrants.

After getting out of prison for the second time, he found himself with a business idea and promised investors 50% profit within 45 days or 100% profit within 90 days by buying and selling postal reply coupons. Despite being a two-time offender, Charles was a charismatic man and a lot of people believed him and invested in his venture.

As you might already know what a ponzi scheme is, it was later investigated and found out that Charles was paying their investors with the money from the newer investors and not from the supposed selling of coupons itself. He eventually went to jail for the third time because of this scheme.

Charles probably didn’t expect that his name would be remembered forever and he would have a huge number of followers even after his death. Here is a short list of the popular ponzi schemes in history:

1. The Largest Financial Fraud in History by Bernie Madoff

2. Indonesian insurance company Jiwasraya that promised customer with a high fixed interest rate

3. The biggest ponzi scheme in Chinese modern history, Ezubao P2P lending

Have you ever heard the phrase “If it’s too good to be true it probably is”? For the context of investment vehicles, I will revise it a bit and make it my third mental note:

Mental note 3: If it’s too good to be true, it’s probably a ponzi scheme

There are five features of a ponzi scheme (source).

1. People invest into it because they expect good profits, and

2. that expectation is sustained by such profits being paid to those who choose to cash out. However,

3. there is no external source of revenue for those payoffs. Instead,

4. the payoffs come entirely from new investment money, while

5. the operators take away a large portion of this money.

Pump and dump scheme and pyramid scheme are in my opinion, just a variation of ponzi. They are different, but in a lot of ways are the same. A lot of avarice and human folly is involved. A lot of people are either fooled or become completely deluded. This type of scheme will keep on flourishing as long as there are investors more foolish than the previous ones buying into the investment vehicle.

When encountering an investment that promises high upside and little to almost no downside, always treat it as another ponzi scheme. You can then work backward, gather facts, and try to prove yourself wrong.

If you can’t prove yourself wrong, it probably is a ponzi scheme.

Know that in fact, a lot of people still put a great chunk of their money even when they fully know that it is ponzi. They just think there will be more people more foolish than themselves. If you put into perspective my second point about how humans will always be greedy, it makes a lot of sense.

Remember what I wrote at the beginning of this post about how mentally painful it is to be a victim of fraud. I don’t want any more people to go through the same pain.

I hope I’m not too preachy and you get something from this post.

I create this little space on the internet to write my thoughts and reflections on being a human, a woman, and a software developer. I don't have Instagram/Twitter but I can be found on LinkedIn. Feel free to contact/give feedback/tell me your story through my email: ivanaairenee@gmail.com