Pyramid scheme

Pyramid scheme diagram

Airplane game

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Pyramid scheme is a business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or selling products. As recruiting multiplies, recruiting becomes quickly impossible, and most members are unable to profit; as such, pyramid schemes are unsustainable and often illegal.

Overview

A pyramid scheme is characterized by a few people (top of the pyramid) making large amounts of money, while newer members (bottom of the pyramid) make little to no money. The scheme requires a constant influx of new participants to sustain itself. The model is called a "pyramid" scheme because of the shape of the business model, resembling a pyramid with a broad base and a point at the top.

Operation

The premise of a pyramid scheme is relatively simple. An initial recruiter recruits investors with an offer of high returns in a short period. These initial investors are then required to recruit more investors and so on. Each member is promised earnings from the individuals they recruit directly, as well as an indirect return from the recruits of their recruits, and so on. Therefore, the recruitment chain grows exponentially, and the flow of money upwards gives the illusion of profitability. However, since the number of people willing or able to join the scheme is finite, the pyramid collapses when it becomes impossible to recruit the required number of new members.

Legal Status

Most countries have laws against pyramid schemes. In the United States, the Federal Trade Commission (FTC) warns against the participation in such schemes and takes action against them. Pyramid schemes are often confused with legitimate multi-level marketing (MLM) businesses, which are legal. The key difference is that MLMs generate revenue from actual products or services, whereas pyramid schemes generate revenue solely from recruitment.

Identification

Identifying a pyramid scheme can sometimes be difficult. However, some red flags include:

• Promises of high returns in a short period.
• Emphasis on recruiting new members over selling a product or service.
• Requirement to pay to join.
• The company has no genuine product or service.

Consequences

Participants in pyramid schemes are at risk of losing their investment and facing legal consequences. Pyramid schemes also harm relationships and can lead to social stigma for those involved.

See Also

• Multi-level marketing
• Ponzi scheme
• Investment fraud