What Are Ponzi & Pyramid Schemes?
People often look for easy, quick and low-risk investment options which sometimes also lead them to become a victim of fraudulent investing scams. Ponzi and pyramid schemes have been known to the world for over a century now yet many people still become an investor and eventually a victim because of lack of research and desire to earn high returns with little risk.
These schemes only operate for a short period of time but the money people make on the top of the chain is huge. An investment in such a scheme in Pakistan can even begin from a few thousand rupees and go as much higher as the capacity of a person. If you don’t know about the existence of such schemes or just know them by name and don’t understand how these schemes work, you have come to the right place. This blog gives a complete understanding of Ponzi and pyramid schemes and how to identify them.
Ponzi And Pyramid Schemes – The Difference
The basic motive behind both Ponzi and pyramid schemes remains the same i.e. to con people by convincing them to invest sums of money in a seemingly lucrative business venture. However, in the next few weeks or months, only the initial layer of investors would have gotten a few instalments as a return on their initial investment and the remaining would have become the victim.
Before we get into how these schemes work and how you can identify them, let’s understand the difference between a Ponzi scheme and a pyramid scheme.
What Is A Ponzi Scheme?
The name Ponzi scheme was derived from a trickster named Charles Ponzi in 1920 who promised very high returns in a very short time. Although the swindler was arrested his method was followed by many to make big bucks.
A Ponzi scheme is heavily dependent on new investments and a company committing this type of fraud makes various efforts to get new investors onboard. As new investors keep coming, the income is used to pay initial investors as profits they made on their investment which is only the money raised from new investors. It is important that new investments keep coming for a Ponzi scheme to keep running. As soon as the flow of new investment starts to drop, investors start withdrawing their money; consequently, the scheme falls apart and investors become a victim of a scam.
What Is A Pyramid Scheme?
A pyramid scheme is started by an individual, business or corporation where only the party on the top of the pyramid makes money. It is named pyramid scheme because its model looks exactly like a pyramid.
The party on the top of the pyramid recruits individuals who have to pay the owners a sum or a fee as a joining privilege. Every new individual will hire more people who will pay them the joining fee, a percentage of which will also be paid to upper tiers, and the network keeps growing. As new players keep entering, the owner keeps making money but after some time, the pyramid stops growing and that is when it shuts down. By that time, players on the top level have made loads of cash while most of the players on lower tiers have to walk away empty-handed.
A pyramid scheme is, in a way, similar to multi-level marketing (MLM). The only difference is that it actually sells tangible goods, however, the recruits do not necessarily have to sell goods, instead their revenue streams are highly dependent on recruiting new members.
How Do Ponzi And Pyramid Schemes Collapse?
Even though these are fraudulent, the motive and model of these schemes is to generate as much money as possible. The Ponzi scheme is dependent on the new investors getting on board to invest money but as soon as new investments stop coming in or the inflow of cash decreases substantially, the scheme will cease to exist.
For a pyramid scheme to sustain, it is important that the lower tiers are always bigger than the upper tiers to sustain the model. But naturally, the model is not sustainable because eventually lower tiers will not be able to recruit new members and the pyramid will eventually tumble.
Characteristics Of Ponzi And Pyramid Schemes
With changing technology and people finding new ways to scam people, it is getting highly difficult to differentiate scams from legitimate investment opportunities. It is difficult to tell apart but not at all impossible. You just have to pay extra attention to some features and characteristics because some of these will be found in all such schemes.
|Characteristics Of A Ponzi Scheme
|Characteristics Of A Pyramid Scheme
|High returns and minimum risk
|Consistency in returns
|The source of revenue is recruiting new members
|Constant emphasis on new recruitments
|Difficulty in receiving payments
|Complex commission structure
Characteristics Of A Ponzi Scheme
Following are the characteristics of a Ponzi scheme:
High Returns And Minimum Risk
Investing money in a business venture will always have some risk involved in it. It is true that investments that yield high returns also have higher risks involved but there is uncertainty too in that. Ponzi schemes will offer high returns and minimum risks which is almost impossible to achieve.
Consistency In Returns
The initial investors will consistently get positive returns but the same cannot be said about investors joining later. However, the investors should do a thorough background check on the company and the overall market condition. Consistent returns regardless of the uncertainties in the market should be a caution sign for the investors.
Registration of a firm with the Securities and Exchange Commission of Pakistan (SECP) gives investors information about the product or services of a firm. Typical Ponzi schemes are not registered with SECP so investors will find only limited information.
Difficulty In Receiving Payments
With Ponzi schemes, the victims will have trouble withdrawing their payments and even face problems if they want to cash out all their investments.
Characteristics Of A Pyramid Scheme
Following are the signs of a pyramid scheme:
Same as the Ponzi scheme, a member of the pyramid scheme will be promised fast returns or cash. Instead of selling the main product of the business, members will be paid by recruiting new members.
Source Of Revenue
The source of revenue, as discussed above, is not by selling actual products or services. If you observe that the company or a website is generating revenue through invaluable products or services like watching advertisements on a website that seems to have very low viewership, it is most definitely a pyramid scheme.
If you are given money to post ads on a website that is hardly used by anyone or recruit new members on the platform, it is an illegal pyramid scheme.
Constantly Emphasizing On New Recruitments
To become part of a pyramid scheme, you will be asked for a joining fee and bring others to the network for its speedy growth. One must be sceptical and suspicious about hiring new members for a fee to get a percentage on new recruitments.
If the commission structure is based on selling products and services, it is a legitimate business. Pyramid schemes have commission structures based on hiring new recruits and if it is hard to understand the commission structures that go beyond the business model, you should be cautious about becoming a part of such an organization.
Such schemes exist in different forms and businesses and people all over the world lose their hard-earned money to such scams. As long as you are unaware of such scams, the only guilty party is the business owner who started a Ponzi or pyramid scheme to con people.
The SECP has been warning people and investors about schemes that offer high returns, minimum risk and unrealistic incentives or commissions. There is no such thing as easy money. Only higher risks yield higher returns and even those have a huge element of uncertainty.