What are Ponzi and Pyramid schemes?

What are Ponzi and Pyramid Schemes?

What are Ponzi and Pyramid schemes?

Investments offer a huge potential to maximise profits. Yet, a lot of people are terrified of venturing into investments because of the risks associated. Scammers, fraudsters realizing this have devised a devious means to rob people of their hard-earned funds masking as investment schemes. Some of those prominent scams deployed by these fraudsters are Ponzi and Pyramid schemes masked as highly profitable ventures with little or no risk. What then are Ponzi and pyramid schemes, and how can they be identified to safeguard our funds?

What are Ponzi Schemes?

However, this investment does not have a structured business model to earn profits. What the organizer does instead is to find new investors and uses their funds to pay off old investors. It is synonymous with robbing Peter to pay Paul. In this case, the old investors are convinced to bring more investors to the investment scheme. The funds raised for the new investors are then used to pay the older investors.

However, the Ponzi scheme begins to unravel when there is difficulty in finding new investors. This is because older investors can no longer be paid, and that is when often most people begin to realize they have fallen for a Ponzi scheme. Since the investment scheme has no legitimate source of income, the focus is on finding new investors to add to the Ponzi scheme.

Ponzi scheme was named after Charles Ponzi, a swindler who lived in 1919. Ponzi scheme had existed long before Charles Ponzi, yet; Charles Ponzi pulled one of the biggest Ponzi schemes, which explains why it was named after him. At first, Charles Ponzi operated a legitimate business using arbitrage to earn profits. Charles's investment scheme focused on the US postal service, which at that time allowed a person to pre-purchase postage using international reply coupons. The receiver of the correspondence could then exchange the coupons and exchange them for priority airmail postage stamps which were more valuable. Ponzi was able to make profits through this, but then he got greedier. He had a company, Securities Exchange Company which was integral in his Ponzi scheme. He promised investors about 50% profit in 45 days and 100% profit in 90 days. People trusted Charles Ponzi because of his success with the postage stamp scheme and were quick to invest. However, rather than investing the funds in the postage stamp scheme, he instead redistributed it among investors who were convinced they were making a profit. However, Charles Ponzi's scheme unravelled when he was investigated by The Boston Post and subsequently arrested on counts of mail fraud.

Ponzi schemes may take any shape or business model depending on the preference of the Ponzi organizer. Those who are able to make any real profit are those who get into the Ponzi scheme earlier, while the last sets are often left with nothing. Studies have shown that often investors always feel a sense of shame after falling prey to Ponzi schemes. This makes them hesitant to report the organizer to law enforcement agencies. Some even go ahead to protect the interest of the Ponzi organizers because of threats that repayment may get delayed if they involve law enforcement agencies. They are faithful and willing to go to lengths to protect the organizer's identity with the hope of recovering their funds, but often this is never the case.

How to identify Ponzi schemes

Ponzi schemes have evolved over the years, with technology being manipulated to help attain their devious plans. However, it is important to recognize certain red flags that distinguish Ponzi schemes from other investment schemes to protect your funds. When approached with an investment scheme, you need to be cautious and on the lookout for these signs:

  1. Unrealistic high investment returns
    The first red flag you would notice about a Ponzi scheme is their ridiculously high investment returns. Investments can be highly profitable, especially long-term investments. Yet, short-term investments that offer abnormally high investment returns that are difficult to achieve with conventional investment schemes smell like a rat. Ponzi schemes may take different shapes, but they often offer unrealistic high investment returns within a short time frame.
  2. Guaranteed returns with little or no risk
    When the word "guaranteed" is associated with an investment, you should perhaps take a step back and reconsider that investment scheme. Investments are often so profitable because of the risks associated with them. In fact, some may say, the higher the risk, the great the profit." Therefore, investment schemes, especially those that claim to be so profitable, such as the Ponzi scheme, should have considerable risks. However, Ponzi promoters often promise guaranteed returns on investments to attract investors. You should be highly cautious when offered an investment scheme with high returns but no risk.
  3. Pressure to invest and seek out more investors
    The survival of Ponzi schemes is mainly dependent on the continuous addition of new investors. Without new investors, the Ponzi scheme would unravel or crumble. The investor, in an attempt to keep the Ponzi scheme afloat, may consider raising the returns, but when this all proves ineffective, the Ponzi scheme would surely crumble.
    In order to keep the investment scheme afloat, they would pressure investors to invest and reinvest. They would make you out to be unintelligent or not driven if you fail to invest in this scheme. A false sense of urgency would be created in the investors, convincing them that the investment opportunity is available only for a limited time. You are convinced to act now or forever regret missing a once-in-a-lifetime opportunity. The pressure or force to act now is a notable red flag you should put in mind when investigating an investment scheme.
    Apart from being pressured to act fast, you are encouraged to bring new investors and sometimes even offered a reward as an initiative. If you find yourself being pressured to find investors, then perhaps you are gradually being roped into a Ponzi scheme without being aware.
  4. Lack of a structured business model
    Ponzi schemes are designed to attract investors and have no real viable or structured business model. An investment scheme that doesn't have a viable or structured business model might just be a Ponzi scheme. An investment scheme that its business model is difficult to understand and the source of its return is not clear is sounding alarm bells.
    Clients are sometimes not even given access to paperwork that concerns the investment schemes. The ones with access find it difficult to understand or explain. You should be wary of investment schemes that are not structured on their investments and returns or are complex to understand.
  5. Credibility only by association
    Several investments that operate a Ponzi scheme are hardly ever registered with the Securities and Exchange Commission, which is state-specific. That is, different states have licensing requirements investment enterprises have to meet. Still, more often than not, Ponzi schemes never meet these requirements. Ponzi schemes get their credibility through association from persons who are in on the Ponzi scheme.
    In order to convince you about the validity of the Ponzi scheme, they would introduce you to persons in their inner circle with tales of the success of the investment schemes. They may also connect you with their early investors so you can be convinced about their credibility.  You should be cautious when considering investments, especially those not registered under the law as an investment scheme.

What are pyramid schemes?

Pyramid schemes and Ponzi schemes share similarities. However, the pyramid scheme has a more structured business model than the Ponzi scheme. As the name suggests, the pyramid scheme is a hierarchical organization set up to extort people of their hard-earned funds masked as an investment scheme. The organizer of the pyramid scheme stays on the top while investors depending on the time in which they were added, may fall below the pyramid scheme.

The organizer or promoter of the pyramid scheme introduces some investors to the investment scheme. These investors are expected to pay specific fees to become a part of this investment scheme. They may also be expected to purchase certain products which in the real sense of it hold little or no value at more exorbitant prices. In order to make back their profits, investors on the second tier of the pyramid have to introduce a new set of investors who also pay fees to join the investment schemes. The second tier may then sell some of their products off to the new members.

The fees paid by the third tier don't belong entirely to the second tier, as the first tier also takes a percentage of the fees paid. The same goes for the fourth, fifth, and subsequent tiers introduced to the pyramid scheme. Those at the top earn more profit while lesser profits trickle down to those at the lower tiers of the pyramid. However, just like the Ponzi scheme, the pyramid scheme would unravel when the pool of investors dry up as they can no longer access funds to pay those at the lower tier. Pyramid schemes are dependent on the fees paid to join the organization, and the lack of new investors to pay these fees spells foreclosure.

Pyramid schemes may also take different shapes or forms, yet most of the time, they are designed like multi-level marketing. You can differentiate them from MLM because the goods or products have no real value. You can only earn your money back by selling them to the next generation of investors. Another form of pyramid scheme operates through chain mails. An email list is created, and investors are encouraged to make significant donations to everyone listed on the mail. After donating funds to the mails, the recipient is told to delete the first name on the list and replace it with their own. The recipient now forwards the new list to his own contacts with the expectation that he would get his initial funds back and some profits. However, these begin to crumble when there are no new investors to donate to persons on the list. Chain mails take different formats, such as Loom in Nigeria. Where persons were added to a WhatsApp group and are expected to donate first to the group. After investors have gotten their funds and profit, they exit the group. At the same time, the recipient now seeks to add recipients to the group who would make donations to make back his initial deposits and earn more.

One of the biggest pyramid schemes ever pulled took place in Canada about 2008. However, participants were fortunate in that the operation was shut down, and they were able to retrieve their funds. However, more often than not, participants lose their funds permanently if the pool of investors dries up.

In the 2008 pyramid scheme, participants were convinced that they would earn a lot of profits from selling low-cost travel club membership plans. However, as a requirement to participate in the pyramid scheme, participants had to purchase a membership which costs about $3,200. Several persons numbering about 2,000 fell for the scam as they were promised about $5,000 for each membership plan sold. However, participants were not provided the full details before joining. They could only realize their profits when they had accumulated up to $100,000 in sales, which meant they had to have sold at least 20 membership plans. Participants soon realized that they couldn't sell up to that amount in a downward economy. Subsequently, they filed a lawsuit that crumbled the pyramid scheme.

Pyramid schemes are considered illegal in most countries, and organizers of the pyramid scheme would be found persecuted if caught. Although participants in the pyramid scheme are not considered guilty, except they are aware they were participating in a pyramid scheme, they often experience unrecoverable losses. They lose their funds and strain relationships with people they bring into the pyramid schemes. It is essential to be on the lookout for signs that define Ponzi and pyramid schemes when pursuing an investment opportunity.

Is Bitcoin a pyramid or Ponzi scheme?

Many questions have been raised about bitcoin. Some critics argue that bitcoin is a well-structured pyramid scheme that would eventually crumble. However, this is far from the truth. Saying bitcoin is a pyramid scheme or Ponzi scheme is simply calling all fiat currencies like Dollars, Pounds the same.

Bitcoin is money but digital, which means that it can perform all the transactions that money can. However, bitcoin and other cryptocurrencies are relatively new, which is why they can often be misunderstood. Yet, for clarity, bitcoin is neither a pyramid nor a Ponzi scheme.


Pyramid and Ponzi schemes are devious means through which scammers take advantage of investors by promising them high profits in the short term. However, investors are often left at their wit's end with no profits and even more losses than they could have accounted for. As enticing as high profits with guaranteed returns may seem, if it often sounds too good to be true, it often is. Therefore, it is vital that you do your own research before investing in investment schemes.

Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.

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