What are Pyramid & Ponzi Schemes: Why You Should Avoid Them
A pyramid and ponzi schemes are both fraudulent business models that promise participants significant profits based on recruiting other individuals into the scheme rather than selling legitimate products or having a legitimate investment strategy. First, we’ll discuss Pyramid Schemes and further into the article we’ll better define Ponzi schemes with examples.
Pyramid Scheme: An Unrealistic Structure
A pyramid scheme is an illegal and unsustainable business structure where individuals are recruited to invest money. They are promised sizable profits primarily for recruiting new participants. Participants are often required to make an upfront payment or buy into the scheme; usually by purchasing expensive products, training materials, or memberships. The scheme relies on a constant flow of new recruits to sustain itself. The reason for this is because the funds from new participants are used to pay commissions or investment returns to those at the top of the pyramid.
As the scheme expands, it becomes increasingly difficult for new recruits to make money, leading to financial losses for most participants. Eventually, when recruitment slows down or stops, the pyramid collapses, leaving the vast majority with financial losses. Only a small group of individuals who joined early end up benefiting.
Illegal in Most Countries
Pyramid schemes are illegal in most countries because they are deceptive and exploit people’s trust and financial vulnerability. It’s crucial to be cautious and avoid getting involved in offers like this to protect yourself from potential financial harm.
3 Famous American Pyramid Schemes
Check out these famous pyramid schemes in the United States where the founders were charged with crimes. Here are a few notable examples:
Bernie Madoff and the Madoff Investment Scandal:
Bernie Madoff, a former chairman of the NASDAQ stock exchange, might be the most famous in recent history. He orchestrated one of the largest and most notorious Ponzi schemes. Operating for several decades, Madoff defrauded thousands of investors out of billions of dollars. In 2009 he was charged with securities fraud, investment advisor fraud, and other crimes. Madoff was eventually convicted and sentenced to 150 years in prison.
Herbalife and the FTC Settlement:
Herbalife was a multi-level marketing company, that was accused of having a business model that resembled a pyramid scheme. After a multi-year investigation, the Federal Trade Commission (FTC) reached a settlement with Herbalife in 2016. Herbalife agreed to pay $200 million in consumer compensation and to also restructure its business practices to prevent deceptive practices associated with these schemes.
Zeek Rewards was an online penny auction and investment program that operated as a Ponzi and a pyramid scheme. In 2012, the U.S. Securities and Exchange Commission (SEC) shut them down. The founder, Paul Burks, was charged with operating a $900 million Ponzi scheme. Burks later plead guilty to securities fraud and tax evasion charges.
There are legal consequences associated with pyramid schemes. It’s crucial to exercise caution and discernment before investing in any opportunity. Don’t fall victim to fraudulent schemes.
Was FTX a Pyramid Scheme?
No, FTX is not a pyramid scheme. FTX was a cryptocurrency exchange and trading platform that was founded in 2017 by Sam Bankman-Fried. It gained significant popularity in the cryptocurrency community and was thought to be a reputable and legitimate platform for trading digital assets.
However, FTX investors filed a class action lawsuit against FTX and its celebrity endorsers on Nov. 15, 2022. The civil suit claimed FTX used “false representation and deceptive conduct.” FTX was also accused of using a Ponzi scheme to misuse funds and move customer money between entities. Since the scandal Sam Bankman-Fried has largely been confined to his parents’ home since his December arrest in the Bahamas, where he had lived and where FTX was based. As of Feb 24, 2023, Authorities have said that, if convicted, Bankman-Fried could face 115 to 155 years in prison.
Another Famous Scammer
Martin Skrelie, the man who rocketed the price of lifesaving drugs up more than 4,000%, only served 4 of the 7 years he was sentenced to. His sentence also included 7.4 million in fines plus another $64.6 million in a civil suit to repay his victims. Here’s the CNBC article that outlines the Martin Skrelie case: https://www.cnbc.com/2022/05/18/martin-shkreli-released-from-federal-prison-into-halfway-house-.html
Pyramid schemes, as mentioned earlier, are fraudulent business models that rely on recruiting participants and do not involve the sale of legitimate products or services. FTX, on the other hand, supposedly operated as a regulated cryptocurrency exchange where users can buy, sell, and trade various cryptocurrencies.
Clarifying the Difference Between a Ponzi Scheme and a Pyramid Scheme.
While both schemes are fraudulent in nature, they operate differently:
The key distinction lies in their primary method of operation. Ponzi schemes focus on investment returns using new investors' funds, while pyramid schemes emphasize recruitment and building a hierarchical structure.
A Ponzi scheme (named after Charles Ponzi) is an investment fraud where the operator promises high returns to investors, typically using funds from new investors to pay earlier investors. The scheme relies on a constant flow of new investors to sustain the illusion of profitability. Here are the key characteristics of a Ponzi scheme:
- Promise of high return: The operator entices investors with promises of unusually high or consistent returns on their investments.
- Unsustainable financial model: Existing investors are paid using the investments of new participants, rather than through legitimate investment activities.
- Lack of legitimate investment strategy: The scheme typically lacks a legitimate business or investment strategy to generate the promised returns.
- Collapse and loss: Eventually, when new investments slow down or run out, the scheme collapses, and most participants lose their money.
A pyramid scheme is a fraudulent business model that focuses on recruiting participants and building a hierarchical structure, rather than selling genuine products or services. Participants at higher levels profit from the recruitment of new participants who make upfront payments or invest money. Here are the Key characteristics of a pyramid scheme:
- Recruitment-based rewards: Participants are promised financial rewards primarily for recruiting new members into the scheme.
- Emphasis on recruitment: The primary focus is on recruiting new participants, rather than selling legitimate products or services.
- Unsustainable structure: The scheme becomes unsustainable as it relies on an ever-increasing number of recruits to support the existing members.
- Collapse and loss: When recruitment stalls or stops, the pyramid collapses, leaving most participants with financial losses while benefiting only a small group at the top.
While there may be some similarities between Ponzi schemes and pyramid schemes, the key distinction lies in their primary method of operation. Ponzi schemes focus on investment returns using new investors’ funds, while pyramid schemes emphasize recruitment and building a hierarchical structure.