What Is A Pyramid Scheme?


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Definition and Concept

A Pyramid Scheme is a business model which relies on recruiting an ever-increasing number of members, starting with the top-level members, and gradually increasing in size. This scheme generates money through the costs that new members must pay to existing members and this cycle continues indefinitely.

In simpler terms, a pyramid scheme generally has the following progression: John founded a scam company which follows the Pyramid Scheme model. He then recruited 10 more people who pays him money to join the company. These 10 people in turn each recruit 10 more new members of their own, who all must pay money to those who recruited them and John (totalling 100 people). To make a profit, these 100 people each recruited 10 more members to join, and this cycle is repeated indefinitely.

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Through this concept, we can see that the scheme starts with the first level (John) then gradually turns into the second tier with 10 more people, then gradually 100 and exponentially increase with time. As this model gets more and more members, it resembles the shape of the pyramid; hence its name the “pyramid scheme”.

By nature, pyramid schemes are doomed to fail and is unsustainable since it relies almost solely on attracting new members to generate money. As the number of new members slowly decrease, there will be no money being generated and the “pyramid” will collapse. In most cases, the only people profiting from these schemes are the few at the top of the scheme while most members lose all the money that they have “invested”.

Types of Pyramid Schemes

To understand how to avoid pyramid schemes, we must understand the types of schemes that are practiced. Generally, there are 3 classifications of pyramid schemes:

1. Multi-Level Marketing Pyramid Scheme

The most common and generic type of pyramid scheme, this type of business model generates income through the fees paid by new members to those at higher levels. This type of businesses usually does not generate income through the sales of actual goods and services and usually hidden under companies that offer intangible products such as educational courses. In most cases, multi-level marketing is indistinguishable from pyramid schemes.


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2. Chain Emails

This scheme is carried out through chain emails with a listed of names attached which aims at persuading naive recipients to donate money to the names in the emails. After a donation has been made, the recipients are encouraged to add their names to the list and forward the emails to their own group of contacts. In essence, this is a pyramid scheme which uses email as a tool to lure people into donating money to the scheme.

3. Ponzi Schemes

Ponzi Schemes are a special cases of pyramid scheme that does not necessarily adopt the hierarchical structure but nevertheless follows the principal of luring naïve new members to enrich those that have already joined. A Ponzi scheme “artist” tend to work on the premise of “robbing Peter to pay Paul” and essentially moving money from one recipient to another while continuously luring new members, which ultimately creates a false sense of profit for those who fall victim to the scheme. In the end, most Ponzi participants ended up losing everything due to the nature of this scheme.

Why do People Fall for Pyramid Schemes?

There are generally three types of people that would fall for pyramid schemes: those who participate out of greed, those who are misled into believing that the pyramid schemes are “investment clubs” or “gift programs” and those who believe that the products or services being sold by these schemes are legitimate.

1. Those who join out of greed

One of the main reasons why people would willingly join pyramid schemes are out of greed. These people often are aware of the illegal nature of these schemes and are often those who either start the scheme or is one of the “top-level” members. Some of these members are also normal “investors” who believe that the scams will last long enough for them to eventually make a profit. Regardless, most of the participants of these schemes ended up losing a lot (if not all) of the money invested.

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2. Those who were misled

Arguably the most common types of people that is involved in pyramid schemes. Those who are misled are often at the lower level of pyramid schemes which are most likely to lose all of their money. Pyramid promoters often target closely-knit groups such as religious or social organizations, college sport teams and students to easily misled them into investing to the scheme. Peer pressure can also contribute to large amount of people in a community all signed up for a pyramid scheme which usually ended up devastating whole communities at once.

3. Those who join because they thought the services or products are legitimate

Those who falls victims through this mean are often convinced by pyramid schemes under the form of multi-level marketing companies. These companies will often promote or sell products and services that are unsaleable to their victims and would refuse to repurchase them, leaving those who invest in these scams only realising that they have fallen victim when it is already too late.

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How to avoid pyramid schemes?

The rule of thumb to not fall victim to pyramid schemes is to research thoroughly before investing in any products, services, or companies. Try to gather as much information about a company’s marketing plans, sales literature, contracts, business operation records, etc. as possible. Avoid companies that promise lofty goals such as promising to gain an absurd amount of profit through investing small amounts in comparison. In general, if you are unsure about a promotion to invest, do not go through with it and avoid being affected by peer pressure or other factors.

In the end, it is best to always research and conduct your own investigations before making any actions that involve money and spread awareness to prevent the rise of pyramid schemes.

Source and further readings:

https://www.investopedia.com/insights/what-is-a-pyramid-scheme/

https://ag.ny.gov/consumer-frauds/pyramid-schemes

https://duan600.vn/da-cap-la-gi/