top of page

Ponzi Schemes Vs Pyramid Schemes

Updated: Jul 13, 2021

A Ponzi scheme is a fraudulent investment operation, involving a supposed ‘investment portfolio manager’ who actively convinces investors into investing a certain amount of money, by promising a specific ROI at a stipulated time. In a Ponzi scheme, no actual investment occurs, and money from the new investors acquired during the given time pays the old investors. Eventually, the initiator hits a dead end as the scheme is unviable without new investors

The first notable cases of the Ponzi scheme date back to the late 19th century. The Ponzi scheme identifiably obtained its name from a con artist who successfully initiated a fraudulent moneymaking plan, relying on the postal system for arbitrage and fueled by fresh investors as recruits. In essence, Ponzi was “robbing Peter to pay Paul”, paying his foremost investors with money from new investors consistently over one year, before the scheme crashed. At this point, Ponzi was millions of dollars deep in debt to all the investors he could not payback. The investors lost their money, with Ponzi incurring a quarter-million-dollar debt.

Yet, this is not the most notorious Ponzi scheme in history. It is almost impossible to research Ponzi schemes without coming across the name of Bernard Madoff, an American fraudster who superintended the largest Ponzi scheme that lasted almost twenty years, racking up billions of dollars until 2008 when he was eventually discovered. A more recent example of this scheme is the case of North Carolina’s Hal H. Brown Jr., who swindled over sixty people through misrepresentation of his company, Oodles Inc., to build credibility. Going further to expel their doubts by providing false financial statements, Hal scammed family, friends, and acquaintances with his Ponzi scheme before his 17.5-year sentence after he was caught.

At the heart of every pyramid scheme is the concept of multi-level marketing. For instance, it may be an effective business, trading in ideas or skill, or a product; but the instant it involves recruiting new customers or enlisting members to earn a certain percentage of money per head, it becomes a multilevel marketing business model or MLM. On the flip side, it may not be a bona fide business venture or even involve trading anything, yet it can still feasibly operate as a pyramid scheme.

This is contrary to the belief that a major difference between the Ponzi scheme and the pyramid scheme is the presence of legitimate business operations in pyramid schemes. Although this contributes to identifying a pyramid scheme, for the sake of clarity, pyramid schemes can appear as get rich quick schemes, but also present themselves in MLM business organizations. It is best to envision pyramid schemes in the latter context, as an inherently fraudulent marketing tool used by MLM companies and business organizations to play an advantageous game they have ascertained to win. Most of these companies promote the efficiency of their products or platform promising value, but this is only a guise to attract members to join their organization, and pressure them to attract more members. Yet, they are not to be confused with legitimate multilevel marketing business models; these are authentic business organizations, which employ multilevel marketing as a tool to promote their already profitable products or services.

The pyramid scheme thrives on the ability to introduce new members, and ignite a link of members recruiting more members, to scale higher up the pyramid. In most cases, the members do not derive any real value from their products or platform; but are instead occupied by their focus on enlisting new members to earn a profit, especially because this is their avenue to earn any real profit in the company. Eventually, only a few distributors or members at the top of the pyramid earn any real money. Although, there are a few cases in which the organization offers a valuable product or service, which attracts customers and proves to be quite beneficial to them, they are MLM organizations who pay their recruiters bonuses from the sales profits made by their downlines. These cases may involve a pyramid scheme as a marketing tool, but the company is not fraudulent in its entirety, albeit unethical.

The name ‘pyramid’ derives from the analytical structure of profit distribution amongst its members or participants. The originators and earlier investors at the zenith of the pyramid share a percentage of profit, paid by the newer larger members at the bottom of the pyramid.

Are Ponzi Schemes the Same as Pyramid schemes?

Many people use the words Ponzi and pyramid schemes interchangeably, perhaps rightly so. There are some similarities between them, particularly in their methods of operation, being fraudulent and unethical in nature. Yet, on the surface without diving into their peculiarities, it is believable that they are the same thing and only synonymous phrases for each other. No, Ponzi schemes are not the same as pyramid schemes and despite their similar operations, they do not function the same way. Although they both revolve around the concept of recruiting new members or investors, there are specific differences between both. In what ways are pyramid and Ponzi schemes alike then? Aside from the obvious feature they share, they are ultimately quite different.

How is a Pyramid Scheme Different from MLM?

It may be easier to think of pyramid schemes as multilevel marketing that has cut corners. That way, pyramid schemes are just a hoax formatted as multilevel marketing pulling the wool over their members’ eyes. However, it is not that simple. Pyramid schemes may come fully clothed or completely naked; the former is simply a pyramid scheme hiding behind the front of a legitimate MLM organization, and the latter a ‘get rich quick’ scheme involving active recruitment to earn quick profits. The defining detail in distinguishing these two from each other is simply that in an MLM, profit made from sales by the recruiter’s down line pays the recruiter’s bonus. While in a pyramid scheme there are little to no legitimate sales, and the earlier investors are paid directly from the membership fee or investments of new members instead of profit from any sales. Still, many get-rich-quick schemes are disguised as legitimate MLM companies to attract distributors.

How can you identify a pyramid scheme easily? The initial, glaring indicator of a pyramid scheme in operation is usually the urgent pressure on distributors to admit new members into the company. There is minimal focus on whatever services or products they provide, which is a major part of their referral scheme and how you can earn huge amounts of profit from it. Now, this opens the door to another big tip-off for pyramid schemes, which are certified earnings and the promise of employment that requires little effort with huge rewards.

An MLM organization is a business offering a service or product they deem valuable or beneficial to their customers, while using a multi-level marketing strategy to encourage sales and widespread distributorship of those products. For instance, the IM mastery academy offers training on Forex trading, digital currencies, and assets while operating a multilevel marketing business model. Although IM markets recruiters offer the opportunity to make money by introducing active new members to their platform, they concentrate on selling their services that are efficient and valuable. The aim is to refer active members (with the emphasis being on active) who are ready to invest, patronize or market their products. This simply means that if your down lines are unable to make profitable sales from marketing the company’s products, you cannot receive a percentage bonus. Therefore, it is deceptive to say this is an employment opportunity with guaranteed income. These are perfidious marketing strategies to persuade you into a pyramid scheme. Additionally, promoters of a pyramid scheme make compelling call to-action statements to motivate a person into hastily joining their scheme. This is an indication of foul play, as shrewd decision-making is a vital part of investing. Any investment opportunity that incites a hasty decision and proposes no risk is a fraud.

What is the Difference between Ponzi Schemes and Pyramid Schemes?

The easiest difference to spot between a Ponzi scheme and a Pyramid scheme is their particular method of operation. While the pyramid scheme depends on its investors or members to recruit active new members as a condition to earn profits, Ponzi schemes have no concern with inciting new recruitments or referrals. Instead, trust is built in the victim by reviews of earlier investors who have claimed to receive their ROI at the stipulated time. This attracts new investors to this scheme. Another important point is that while pyramid schemes require a great deal of convincing, hard sells and marketing to expand, Ponzi schemes require little to no direct pressure to convince investors.

From the Journal of Forensic & Investigative Accounting, Vol 4, Issue 1, 2012 on understanding a Ponzi scheme:

“…overall, the interviews reveal a fraud with the following characteristics: …(b)a plausible story that traveled by word of mouth amongst people who knew each other well; (c)demonstrated returns over several months (people often watched others get checks for a few months before investing themselves);(d) low pressure (no urgency to invest)…”

This excerpt explicitly discusses the imperceptible tactics of a scammer operating a Ponzi scheme. The opposite is the case for pyramid schemes, which involve an exigent call to action posed as an exciting opportunity for you.

In Ponzi schemes, the fraudster acts as an ‘investment manager, or ‘investment portfolio manager,’ claiming to possess the skills or credible experience to put the invested money to work. On the other hand, pyramid schemes start from a group of people who create an ‘investment’ chain link by enlisting some investors, who also enlist another set of investors. A different perspective is that while the Ponzi scheme is generally disguised as an opportunity to make passive income through investments managed by an expert at the helms of affairs, pyramid schemes propose an avenue to earn profit through active referrals. Also, Ponzi schemes are much easier to sustain for a shorter period, unlike the pyramid scheme, which operates an improbable unsustainable structure. Even then, it is easier to unravel a Ponzi scheme and identify it for what it is, dissimilarly to a pyramid scheme. Hence, they are easier to prosecute under the law, especially since a single individual perpetrates it. This is dissimilar to a pyramid scheme founded by an organization or a group of people with strong legal backing (as most corporations have). More importantly, the differences between a pyramid scheme and an MLM are not conspicuous to an outsider (save for a few indicators, and an exception in cases where there is no legitimate business involved); while the former is illegal, the latter is very legitimate. Therefore, it is a little more complicated to identify or prosecute.

Is the Cryptocurrency Industry Better at Preventing these Schemes than Traditional Market?

Cryptocurrency has indeed opened up a plethora of opportunities to investors and traders alike, but not without leaving out the scammers. It has become a tool used by internet fraudsters to regenerate a different method of Ponzis. An example is the embezzlement of initial coin offerings (ICO) on the ethereum blockchain, referred to as “smart Ponzis” by the Financial Times. Based on the analysis, both cryptocurrencies and Ponzi schemes operate on the economic theory of the “greater fool” possessing no innate or fundamental value. For cryptocurrencies, the price increases as its demand increases, and in turn, the demand increases as the prices climb higher. Yet in the case of Ponzi schemes, there is no value offered whatsoever; it relies on e ‘greater fools’ to join as new investors.

Internet fraudsters have defrauded a vast population of crypto investors of billions of dollars, using a combination of old-fashioned and advanced technological strategies to swindle victims of cryptocurrency, or through schemes involving digital currencies. In some cases, fraudsters easily appeal to investors’ urge to earn huge ROI, which they promise on their investments. While in other situations, swindlers out rightly lie and deceive investors of the benefits of a nonexistent digital currency. An example is the owners of the OneCoin cryptocurrency, swindling investors of almost $4 billion, by convincing them their digital currency was genuine. From serious observation, a major obstacle for cyber scammers or extortionists before the arrival of bitcoin and its family, was receiving the funds acquired from their extortion schemes. Internet transfers and bank deposits could easily be tracked to expose a cyber-crime and apprehend the fraudster. This is the reason why anonymity that accompanies dealing, trading or investing in digital currencies is advantageous to cyber criminals. Contrary to the perception that cryptocurrencies are naturally guarded against security frauds, it is quite favorable for internet fraudsters. Access to cryptocurrency is easy, with no central control, permanent transactions; Volatile complicated systems, which easily entice victims to fraudulent investment schemes like Ponzi schemes, the market enables these schemes more effectively than the traditional market.

In addition, cryptocurrencies create a better avenue for security frauds. They have not proven to be better at preventing Ponzi or pyramid schemes by the structure of their markets. It may be a bold claim to state that the traditional market is more effective at preventing security frauds, but it is undeniable that in a traditional market, security frauds are efficiently monitored, and prosecuted to some extent. With the digital currency market, investigations into security frauds are not as straightforward. In the conventional market, there exists more accountability and liability. Truthfully, it is easier to dissect and critically analyze these schemes from an impersonal observational study. However, many of these schemes seem like innocent business opportunities, or investment plans when many people are directly confronted with them.

It is advisable to be shrewd and attentive to strong indicators; decision-making in investing should be undertaken carefully. Even more so, if there is undue pressure to take quick action or ‘grab a once in a lifetime opportunity.’ Finally, the participants in a Ponzi scheme or pyramid scheme are not liable for security fraud or illegal transactions as long as they are of course, ignorant of the scheme. The parties liable for these illegal schemes are their originators.

Regardless, it is important to understand that a Ponzi scheme is fundamentally different from a pyramid scheme, even though both are illegitimate, fraudulent ventures; whereas an MLM, which is a legitimate business model, is very different from a pyramid scheme.

Love what we do with our dWeb Guide Insights? Follow us on facebook to stay up to date.

bottom of page