Two of the most popular types of scams, at least by name are the pyramid scheme and the Ponzi scheme. They have popped up many times in history and still do today, continuously morphing to hide better in the present terrain. The two of course share a similarity which is that people lose their money but there are some differences between them that we should be aware of. Knowing these differences helps you to first correctly identify if you’re dealing with either of these and secondly how to avoid it. So let’s understand these two scams and their unique features.
Since Charles Ponzi’s 1919 mail-based scam many versions of it have come up and they all feature the same practice. The Ponzi scheme encourages people to invest in an “asset” that promises great returns though this isn’t always necessary, it may be simply to store value. The schemes usually feature a sort of lock-in or vesting period before you can cash out. When you cash out your money is paid. Sounds great. The magic behind the curtain is of course that the money isn’t coming from the asset or investment but rather from money being paid in by new investors. Yes, your money never went into an asset. No value was generated. Eventually Ponzi schemes collapse, we will look at how later.
So-called because of its organisational structure the pyramid scheme pays benefits to people for recruiting more people to the scheme. They vary in design and system but ultimately, each person makes money based on the number of people recruited under them. The greater your network, the greater your rewards. This structure is found in multi-level marketing (MLM) businesses but pyramid schemes take advantage of this structure. Sometimes they will have a product that is questionable at best but in many cases, they will have no product or at least not one of value. They will usually stress the recruitment of new members. These too eventually collapse but it’s a lot harder and takes a lot longer than a Ponzi scheme.
Investment vs Business
Ponzi schemes are for the most based on you investing money into an asset or investment product. So you may be asked to simply invest money or there may be something slightly more complex like licences or rights. Ultimately you are asked to put money into something that will produce more money. In a pyramid scheme, there is some sort of business going on. You may be asked to pay a membership fee or purchase inventory if there is a product but other than that you are generally taking part in what seems like a legitimate business. They rarely ask for much money, whereas Ponzi schemes will, not at first but eventually command a large investment.
Deposit vs Recruitment
Ponzi schemes are usually based on encouraging you to deposit money or something of value. What Ponzi will rarely encourage you to do is ask friends and family to join the organisation or investment. Pyramid schemes on the other hand will not only encourage but may even manipulate you into encouraging friends and family to join the organisation or investment. They may manipulate you by putting a term that requires you to pay a certain amount if you fail to recruit a given number of new members. Ponzi schemes do not normally push recruitment and you will see why shortly.
Ponzis pay at first
Ponzi schemes are particularly effective because they pay out money, at first. All the sense in the world cannot discourage a person who just received 5 times their money in 2 weeks. This is the reason why Ponzi schemes are not heavy on recruitment early on, a scheme that grows too fast needs to pay out too many people. So a slow, evidence-based recruitment model suits them better. After getting 5 times your money you are ready to bet your life savings and tell everyone you know they can too. Pyramid schemes rarely have any meaningful benefits early on. In fact, if the rewards are low they are just likely to push you to recruit more people.
Pyramids die hard
The Ponzi scheme’s downfall is mathematical. Simply put you can pay some people 5 times their money in two weeks from new recruits but eventually, that number becomes too big. However, what we see more often are the owners of Ponzi schemes running away before this mathematical event. Pyramid schemes are a lot harder to kill especially where they are not built on a meaningful product. They can go on forever. A good example is the gifting clubs which combine the best features of Ponzi and Pyramid schemes.
So the things to look out for are whether there is a business or investment, do they stress deposit or recruitment and if they have made meaningful payouts.