Pyramid Scheme

Pyramid scheme – is an illegal and unfeasible business model based on recruitment of new members by promising them fast and significant profits. The hidden agenda of this recruitment lies in entrance fees that participants have to pay in order to be accepted in. The scheme, which is often called a scam, exists on these payments and collapses when they come to an end eventually.

The pyramid starts with an initial group of top members, whose intentions are to lure in new members. These members, in turn, along with their investments pay the fees for taking part in business, thereby returning some amount of invested money to the top members. Then the recruitment continues. Each new wave of participants covers the expenses of the previous one and the group of top members as well. Usually, people are attracted to such schemes by the opportunity of gaining fast money. This opportunity can cloud their thinking. Consequently, they don’t always weigh the consequences of their decisions.

The key characteristic of the pyramid is participants’ unawareness of its income source. The scam is typically covered by some legal activity like selling goods or providing services. But in fact, the scam is based on the participants’ money instead of proceeds from sales. For this reason such affairs are forbidden by law in the US, France, Russia, Canada, Australia, and some other countries. The organization of the pyramid as well as taking part in it by recruiting people are considered as criminal activity in these countries.

Pyramid Scheme structure

Basically, the pyramid scheme is called so because it has the shape of the pyramid. It starts with one person or a little group of profiteers on the top and then grows exponentially getting bigger with each new wave of recruits.

Let’s illustrate the pyramid scheme with the following example and associated picture presented below.

Suppose that some imaginary businessman starts the pyramid scheme. Now he’s on top of the pyramid. Then he lures in 10 recruits by promising them significant profits in a short time. In order to get in they have to pay certain entrance fees. The potential income allegedly comes from a made up business activity, but actually it comes from these payments.

Let’s assume that the recruits agree to these conditions and become new members of the scam. Now each of them is required to find another 10 recruits. The number of participants gradually grows to 100 people. The pattern of recruitment repeats and these 100 people also need to find 10 more recruits each.

As the pyramid grows the flow of money continues to come from the lowest levels of participants to the ones above them. New people return some amount of money to the previous groups and top members by joining the pyramid and paying their entrance fees. Usually by the time of the pyramid’s collapse the top members return all of their investments and even increase it greatly, while the other participants are left empty-handed. However, the pyramid holds the risks even for the top members.

Essential characteristics of Pyramid Schemes

The most important thing that you need to bear in mind about the pyramid scheme is that it’s a swindle. One day the pyramid inevitably crumbles leaving you with nothing except regrets. For the purpose of protecting investors from unprincipled entrepreneurs, the special lists of precautions have been made. For example, one of them was suggested by the Security and Exchange Commission (SEC) in the US. This list defines the following distinctive characteristics of the pyramid scheme:

• cloudy perception of the product or service intended to be sold;
• promise of the sizable amount of returns or profits in the nearest future;
• introductory payments for taking part in business;
• absence of the database on the business processes;
• complicated structure of paying commissions;
• outlined importance of recruiting new members.

Pyramid Schemes types

Chain emails is a kind of shady scheme that nowadays is conducted mostly on the internet through emails. It corresponds with all characteristics of the pyramid scheme. It’s aimed to target naive participants who are ready to take the risks for getting an excessive return on their investments. The potential recruit gets a message on the email with a list of participants. He needs to pay a certain amount of money to everybody on this list in order to get his or her name on it. When the new recruit puts his name on the list the name of the first person in the list gets deleted. Finally, the list has to be sent to all the participant’s contacts. Eventually, this pyramid as any other of them gets shattered.

The Ponzi scheme is another variation of the pyramid named by its creator – Charles Ponzi, who in 1919 speculated with the exchange of the securities. Although it wasn’t the first similar speculation scheme, the scam gets the Ponzi’s name because his case demonstrated vividly one of the main pyramid characteristics – the participants' unawareness of the scam.

Sometimes the Ponzi schemes are considered to be a separate type of scheme similar to the pyramid scheme, but still having some differences. Nevertheless, both of them are based on the deception of the participants and usage of their money. The difference between the Ponzi scheme and the typical pyramid is that the first one promises victims returns of their investments, while the latter promises income from recruiting new members. 

Gifting Clubs is the scheme that attracts people by offering them gifts and prizes (usually, in cash) for inviting new members. For the rest, the process goes the same way – the participants get motivated to involve new members and the pyramid grows.

There are more types of the pyramid schemes, in addition to the aforementioned, which sometimes are more complex than the simple strategy described in this article. Thus, it’s important to make investments diligently.

Comparison of the Pyramid Scheme and multi-level marketing (MLM)

The pyramid scheme is often compared to multi-level marketing (MLM) which is a legal business model frequently based on selling products. Just as the pyramid scheme, it also includes the recruitment of new members, but it doesn’t fully rely on participants’ investment and doesn’t require the entrance fees. The participants of MLM become its distributors and gain profit from selling the MLM products.

At the same time, the system of recruitment makes MLM quite similar to the pyramid scheme. Top members of the MLM as in the pyramid gain earnings from the lowest levels of the model. Despite having the same structure, these business models are different to an extent of their lawfulness. While the one is considered a fraud, the other is a legal activity.

The similarity of these models benefits the swindlers because they can cover their illegal business as the MLM. In order to avoid the risks of involvement in the pyramid you should be attentive and scrupulous in studying the business activity before making investments and stick to the aforementioned rules suggested by the SEC.

Pyramid Scheme example

One of the most famous pyramid schemes is a Russian MMM company established in 1989. Until 1994 the company’s activity was considered legal, but since that time it has started an aggressive recruitment campaign promising people unbelievable returns up to 3000%. According to various estimates, 2 to 15 million victims were involved in this fraudulent scheme and suffered the consequences. MMM collapsed in 2004, but then reopened again in 2011 as MMM Global. 

Reopening of such a dangerous scheme shows that the promise of fast and significant profits still attracts people enough to take the associated risks. Thus, we strongly advise you to avoid taking part in these schemes, even if the promised income is extremely appealing.