What is a pyramid scheme?

What is a pyramid scheme?
Pyramid schemes are illegal scams in which large numbers of people at the bottom of the pyramid pay money to a few people at the top. Each new participant pays for the chance to advance to the top and profit from payments of others who might join later. For example, to join, you might have to pay anywhere from a small investment to thousands of dollars. In this example, $1,000 buys a position in one of the boxes on the bottom level. $500 of your money goes to the person in the box directly above you, and the other $500 goes to the person at the top of the pyramid, the promoter. If all the boxes on the chart fill up with participants, the promoter will collect $16,000, and you and the others on the bottom level will each be $1,000 poorer. When the promoter has been paid off, his box is removed and the second level becomes the top or payoff level. Only then do the two people on the second level begin to profit. To pay off these two, 32 empty boxes are added at the bottom, and the search for new participants continues.

Each time a level rises to the top, a new level must be added to the bottom, each one twice as large as the one before. If enough new participants join, you and the other 15 players in your level may make it to the top. However, in order for you to collect your payoffs, 512 people would have to be recruited, half of them losing $1,000 each.

Of course, the pyramid may collapse long before you reach the top. In order for everyone in a pyramid scheme to profit, there would have to be a never-ending supply of new participants.

In reality, however, the supply of participants is limited, and each new level of participants has less chance of recruiting others and a greater chance of losing money.

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Things you should know about pyramid schemes

They are losers. Pyramiding is based on simple mathematics: many losers pay a few winners.
They are fraudulent. Participants in a pyramid scheme are, consciously or unconsciously, deceiving those they recruit. Few would pay to join if the diminishing odds were explained to them.
They are illegal. There is a real risk that a pyramid operation will be closed down by law enforcement officials and the participants subject to fines and possible arrest.
Why would anyone pay to join a pyramid scheme?
Pyramid promoters are masters of group psychology. At recruiting meetings they create a frenzied, enthusiastic atmosphere where group pressure and promises of easy money play upon people's greed and fear of missing a good deal. Thoughtful consideration and questioning are discouraged. It is difficult to resist this kind of appeal unless you recognize that the scheme is rigged against you.

Disguised pyramid - wolf in sheep's clothing
Some pyramid promoters try to make their schemes look like multilevel marketing methods. Multilevel marketing is a lawful and legitimate business method which uses a network of independent distributors to sell consumer products.

To look like a multilevel marketing company, a pyramid scheme takes on a line of products and claims to be in the business of selling them to consumers. However, little or no effort is made to actually market the products. Instead, money is made in typical pyramid fashion, from recruiting. New distributors are pushed to purchase large and costly amounts of inventory when they sign up.

For example, you might have to purchase $1,000 of nearly worthless products in order to become a "distributor." The person who recruited you receives $500 (a fifty percent commission) and $500 goes to the top (the company, in this case). Notice the similarity to the simple pyramid scheme described earlier.

Most disguised pyramids, however, are not this easy to unmask. Pyramid schemes often choose products which are cheap to produce but which have no established market value, such as new miracle products, exotic cures, etc. This makes it difficult to tell whether there is a real consumer market for the products. The best way to avoid a disguised pyramid fraud is to know what to look for in a legitimate income opportunity.

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