There are lots of illegal businesses promising enormous returns to investors with little or no risk. In most cases, this type of business has no single real product or service to offer. The initiators are so smart and always come up with deceptive lines to lure their victims. Most of the time, they are very successful because people are greedy, looking for a place to reap where they did not sow.

Pyramid and Ponzi schemes are such types of business. Investors are promised a higher Return on Investment (ROI) to lure them. In the end, they are ripped off their hard-earned money. Some of such illegal investments are easy to spot while some hide under the shadow of legitimate businesses to carry out this dubious plan. In this article, we will take a look at how pyramid and Ponzi schemes are carried out.

What Is a Ponzi Scheme?

A Ponzi scheme is a fraudulent investment where early investors are paid from the funds collected from later investors. In such a scheme, there is no legitimate business going on, rather the owners pocket the money while looking for more fish in their net.

They lure their victims by promising high returns. They eventually pay the early investors to gain their trust and lure more people before finally ripping them off. At a point where more people are not joining and there is no more cash flowing in, the scheme falls apart and the operators abscond with the money at hand leaving the later investors with the biggest loss.

The Ponzi scheme was named after Charles Ponzi. He was the first to be associated with such in 1920. He ripped investors of huge amounts of money by promising them higher ROI in postal coupons. He made no single investment but rather held the whole Money while onboarding more investors. The scheme continued till he was not able to get new investors and it finally collapsed. In a Ponzi scheme, nothing legitimate is taking place, rather it is merely the transfer of funds from one investor to another.

Steps of a Ponzi Scheme Process

A typical ponzi scheme follows these steps:

• A fraudster convinces investor A to invest in a non-existing business by promising a high ROI, say 20% at the end of 30 days. Investor A falls into this trap and deposits $2 million.
• This money is not invested in any business but rather resting in the fraudster’s pocket.
• The fraudster goes ahead and convinces investor B to invest. Investor B deposits another $2 million.
• Out of investor B’s money, the fraudster pays investor A 20% and pockets the rest.
• Investors A seeing such will be very happy and even willing to reinvest thinking his initial capital is still intact and will generate more money.
• The fraudster keeps his work going, getting more investors, paying the older ones, and still encouraging them to reinvest.
• This fraud continues till no one is willing to join again and money is no longer flowing in but rather flowing out. At this point, the business will no longer thrive and the scammer absconds with the money at hand.

A Pyramid Scheme

A pyramid scheme is a business model that rewards investors for joining the business and also recruiting more members. The early investors make payments to the business owner in exchange for the right to recruit more investors. The newly recruited members make their payment which is shared between the business owner and the person that brought them. The trend continues and the pyramid gets larger. Ponzi and pyramid schemes are similar as both are fraudulent and get-rich-quick schemes.

Source: Verified.org

A pyramid scheme needs more people to be joining to sustain the business. If more and more people fail to join, the scheme will eventually collapse leaving the investors at the bottom empty-handed. Some pyramid schemes take the shape of a Multi-level Marketing (MLM). This model uses the profit from downlines to settle their recruiters. But in a pyramid scheme, there is no legitimate sale of any product or service. It is simply the sharing of money in different proportions. Some people, after joining the scheme, find it difficult to recruit new members, hence dropping off and going with nothing.

Ponzi vs Pyramid Scheme

Similarities

• Both require new investors to keep joining the scheme.
• Both schemes require a continuous inflow of money to keep running.
• Both are fraudulent and a get-rich-quick scheme.
• Both offer no product or service. It is simply robbing Peter to pay Paul.
• At the collapse of both schemes, the investors at the bottom bear the biggest loss.

Differences

• In a pyramid scheme, the investor is actively involved in recruiting new members while in a ponzi scheme, only the owner does that.
• A pyramid scheme offers the investors an opportunity to make more money while in a Ponzi scheme, a fixed percentage is agreed upon.
• A pyramid scheme takes the form of network marketing while a Ponzi scheme is presented as investment management services.

How to Avoid Fraudulent Schemes

To avoid falling victim to a Ponzi scheme, you can take the following steps:

• Be always skeptical: If an investment opportunity seems too good to be true, it probably is. Be wary of any investment that promises high returns with little or no risk;

• Do your own research: Make sure to do your homework on the company and the investment offer before making any decisions. Consult a range of sources for information, such as the company’s website, regulatory filings, and independent financial experts;

• Check for a legitimate business model: A legitimate business should be able to explain how it generates profits and how it will use your investment. Be wary of any company that is vague or evasive about its business model;

• Use reputable platforms: Use reputable exchanges or platforms to invest. Some of them have their own mechanism to detect and prevent fraudulent schemes.

If any business you intend to invest in shows any of the above signs. It is better to retreat, take your time and do careful research to ensure you are on the right track.

Is Crypto a Ponzi or Pyramid Scheme?

Even today, there are still many people who believe that cryptocurrencies are a ponzi or pyramid scheme. Most of the time, these claims have stemmed from the fact that these people have a lack of understanding of what blockchain and cryptocurrencies are really about. While there have been many examples of fraudulent schemes in the cryptocurrency space, this does not mean that all cryptocurrencies are the same. Many cryptocurrencies are legitimate investments with real-world use cases and a strong team behind them.

Bitcoin, for example, is proven not to be one of these schemes. The reasons are its decentralized nature, which makes it not controlled by any central authority or organization, or its transparency, as the transactions on the Bitcoin blockchain are publicly available for anyone to see. Furthermore, Bitcoin does not promise any specific returns on investment, because its value is determined by market demand.

In any case, you must always keep your guard up because, as already mentioned, fraudulent schemes also exist in the world of cryptocurrencies. Below are some of these.

• BitConnect: This was a high-yield investment program that promised returns of up to 40% per month. It was shut down by the US Securities and Exchange Commission (SEC) in 2018 for operating as a Ponzi scheme.

• OneCoin: This was a Ponzi scheme using cryptocurrencies that guaranteed investors returns of up to 1,000%. Authorities in various nations shut it down, and several people connected to the operation were accused of fraud.

• PlusToken: This was a South Korean-based Ponzi scheme that promised high returns on investments in a new cryptocurrency. The scheme defrauded investors of over $2 billion before being shut down by authorities in 2019.

There have been many other examples of similar frauds that have cheated investors out of billions of dollars. Before making an investment in a cryptocurrency or other type of investment opportunity, it is crucial to take precautions and due diligence.

Conclusion

Both pyramid and Ponzi schemes are fraudulent investment schemes. At their collapse investors are ripped off their hard-earned money and those at the bottom bear the biggest loss. The initiators of both schemes know their plan and they are just waiting for the right time to perpetuate their evil. Ponzi and pyramid schemes might look so enticing at the surface but deep down they are something else. Most people fall victim to scams because of greed and the desire to make quick money with little or no effort. Investment should be preceded by thorough research and evaluation to avoid falling prey to these cheap schemes.