Pyramid and Ponzi Schemes
Most individuals who invest in Bitcoin or other cryptocurrencies or decide to participate in ICO events are usually concerned with two things. First: Return on Investment (ROI), which represents the profits you will ultimately make from the initial investment.
Second: The amount of risk involved in the investment. When risks are too high, investors are likely to lose their initial investment (part or all of it), resulting in a negative investment return.
Naturally, there is always a degree of risk involved in any investment. However, the risk increases significantly in cases where an investor unexpectedly becomes involved in illegal Ponzi or pyramid schemes. Therefore, being able to identify these schemes and understand how they work is of great importance.
What is a Ponzi scheme?
The Ponzi scheme is named after Charles Ponzi, an Italian fraudster who moved to North America and became famous for his fraudulent money-making system. In the early 1920s, Ponzi was able to defraud hundreds of victims, and his scheme continued to operate for more than a year.
Simply put, a Ponzi scheme is a fraudulent investment scam that works by paying older investors using money raised from new investors.
A Ponzi scheme in projects would look somewhat like this:
An investment promoter takes $1,000 from an investor, promising to return the amount to him with 10% interest at the end of the investment term (e.g. 90 days).
The promoter can convince additional investors before the 90-day period is complete. After the end of the period, he will pay $1,100 to the first investor using the $2,000 funds of the second and third investors. It is also likely to encourage the first investor to reinvest the $1,000 again.
By taking money from new investors, the scammer can pay the promised returns to the early investors, convincing them to reinvest and invite more people.
As the scheme grows, the promoter needs to find more new investors to join the scheme otherwise he will not be able to pay the returns promised to previous investors.
Eventually the scheme becomes unsustainable and the promoter is caught or disappears with the money he has.
What is a pyramid scheme?
A pyramid scheme (or pyramid scam) operates in the business sector as a model that promises payments or rewards to members who not only join the scheme but also manage to enroll new members.
For example, a fraudulent promoter offers Alice and Bob the opportunity to purchase distribution rights in a company for $1,000 each. Therefore, they have the right to sell the distribution rights themselves and take a share of every additional member they manage to recruit, then split the $1,000 for recruiting the new member with the promoter in a 50/50 ratio.
In the above scenario Alice and Bob would each have to sell the distribution rights to two new people in order to break even (no profit, no loss) because they earn $500 per sale and each has essentially invested $1,000. Then the burden of selling two copies of the distribution rights shifts to whoever bought them. Eventually the scheme collapses because more and more members need to be acquired to continue the process. The unsustainable development of the scheme is what makes pyramid schemes illegal.
Most pyramid schemes do not offer a product or service and are sustained solely by money raised from recruiting new members. However, some pyramid schemes may be viewed as a legitimate multi-level marketing (MLM) business aiming to sell a service or product. But they usually do this just to hide their underlying fraudulent activity. Therefore, many questionable MLM companies use pyramid schemes but not all MLM companies are scams.
Ponzi vs Pyramid
Similarity
Both are forms of financial fraud that convince victims to invest money by making good promises
Both need a regular influx of new investor money in order to succeed and remain active.
These schemes usually do not offer real products or services.
Differences
Ponzi schemes are usually offered as investment management services and the participants believe that the return they will receive is the result of a real, legitimate investment and the scammer is essentially ripping off one another.
Pyramid schemes are based on network marketing and require participants to recruit new members in order to earn money. Therefore, each participant takes a commission before transferring the money to the top of the pyramid.
How to protect yourself?
Be skeptical: Investment opportunities that promise big or quick returns and require small investments are likely not honest. This is especially true when investing in something that is unfamiliar or difficult to understand.
Be wary of unsolicited offers: Any unexpected invitation to participate in a long-term investment opportunity is usually suspicious.
Verify the seller: The entity promoting the investment opportunity should be investigated. Any reputable financial advisor, broker or broking firm is usually registered by the appropriate administrative bodies.
Don't trust easily, check first: legitimate investments must be legally registered. The first course of action is to request registration information. If it is not registered then a good and reasonable explanation should be given as to why it is not registered.
Make sure you understand investing: You should not invest money in something you do not fully understand. Make sure to take advantage of available resources. Be very careful with investment opportunities covered in secrecy.
Report: It is important to report to the appropriate authorities when investors encounter a pyramid scheme or Ponzi scheme. This will help protect future investors from falling victim to the same method.
Is Bitcoin a pyramid scheme?
Some may argue that Bitcoin is a big pyramid scheme but that is simply not true because Bitcoin is simply money.
Bitcoin is a decentralized digital currency that is secured by mathematical and cryptographic algorithms and which can be used to purchase goods and services. Like fiat money, digital currencies can also be used in pyramid schemes (or any other illicit activity), but this does not mean that digital currencies or fiat money Pyramid schemes.