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A Beginner’s Guide To Pyramid And Ponzi Schemes

It would be completely wrong if someone claims that investing in a particular asset is entirely risk-free. Trading always has some risks attached to it, and these risks sometimes provide gains and sometimes result in complete loss of funds. This remains the same whether you invest in any kind of assets like stocks, forex, commodities, or cryptocurrencies. To lessen the possibility of a loss or fraud, the most common strategy that is used by traders is to reduce the investment. This method indeed reduces the loss, but it also decreases the chances of expected profit.

If the upper given solution is not useful enough, then there must be something else that can be done to keep a safe side. In my knowledge, the biggest threats for traders and their investments are Pyramid and Ponzi schemes, and to avoid being trapped, a trader must be aware of what these schemes are and how they work. These schemes are techniques used by scammers to extract money from naïve traders’ pockets. In this article, I am going to talk about these schemes in detail so that the readers get comprehensive knowledge about them and take the required precautionary measures to avoid them.

These scams have many things in common because they are based on the same concept. Unsuspecting traders get trapped by unethical scammers who promise exceptionally high returns in exchange for their investment. These self-sustaining schemes keep going as long as the cash outflows are matched by monetary inflows and collapse right away when new funds stop coming.

Ponzi Schemes

The history of Ponzi schemes stretches to the 1920s when an Italian swindler came to North America and managed to loot the residents for more than a year. His name was Charles Ponzi, and after that launch of his fraudulent money-making system, he became so popular that this scam was named after him ‘Ponzi Scheme.’

A Ponzi scheme is a scam in which investors are paid from the money collected from new investors instead of actual profits. The operators attract new investors by offering abnormally high returns. The mastermind behind these scams remains in charge of controlling all the activity. They keep on transferring money from one client to another and don’t initiate any investment activities. The basic problem with these scams is that the last bunch of investors don’t get any payment. In some of the reported cases, the scam kept going for more than a year.

The fraudsters earn profits from two ends. First, by charging an operation fee from every client and later on flee overnight with all the money. The cycle goes on until there are no new funds to pay the existing investors. In the end, the investors get nothing except promises, and they never see their money ever again.

The most notorious Ponzi scheme uncovered in recent history was masterminded by Bernard Madoff in his Bernard L. Madoff Investment Securities LLC scam. He established a large network of investors, approximately 5,000, and gathered their money in a single account. He didn’t invest that money in any business, and after the financial crises of 2008, he was not able to carry on the scam. According to SEC, the total funds of investors were around 65 billion US dollars. This scam sparked a controversy in the last quarter of 2008 that is known as Ponzi Mania. In that period, regulators and investment professionals initiated a hunt for Ponzi schemes and fraudsters, and as a result, many schemes were uncovered.

Pyramid Schemes

A pyramid scheme or a chain referral scheme operates in the trading world as a model that showers rewards on members who bring other new members. The new members are then asked the same, to enroll new clients, and as a result, the chain develops. For example, a pyramid scammer offers Lincoln and Scofield a chance to buy distributorship rights of a company for 500 dollars each. After purchasing the distributorship, they will be able to earn on every newly recruited member. The initial 500 dollars collected from sales will then be shared in halves with the promoters.

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In the above-given situation, Lincoln and Scofield need to sell two distributions each to get started and earn 500 dollars per sell. The compulsion to sell distributions to recover the investment is then passed on to their clients. The scheme, at one point, falls apart because more and more members are required, which becomes impossible at a later stage. It is because the number of required new members becomes too large to find. This unsustainable advancement of the scheme makes pyramid schemes illegal.

Some pyramid schemes ask to buy some product like medicines etc. while others are executed only by the money collected from new members. Some pyramid schemes are disguised as multinational marketing companies that intend to sell some services or products to depict as something legal. This is done to cover the ongoing fraudulent activity to manipulate clients and authorities. Legitimate MLMs use the profits earned from downstream sales to pay recruiters, but pyramid schemes have no legitimate sales at all. Although, not all MLM companies are scams, most of them are involved in this unethical business of using pyramid models. But it should also be kept in mind that all pyramid schemes are not illegal. Some businesses use pyramid schemes to promote their legit products. The schemes which don’t offer any product and solely rely on money have more chances of being a scam.

Scammers promote pyramid schemes on various platforms such as print media, social media, internet advertisements, websites, YouTube channels, and spam calls. To promote their schemes, they go to every length and leave no stone unturned. But one thing is for sure that a time comes when it becomes too big for them to handle, and as a result, the scheme collapses.

Differences

Pyramid and Ponzi schemes have many common characteristics which are used to manipulate investors. If you become able to notice these characteristics, you can spot the scams easily. Ponzi schemes are presented as legit investment management services in which the clients believe that they will receive profits as a result of their investment, but the scammers rob new clients to pay the former ones.

Pyramid schemes are executed over a marketing network, and the participants are asked to bring new customers if they want to make money. So every participant takes commission before sending the money to the above node, and the money ultimately reaches the top of the pyramid. This cycle goes on until the last victim.

Another key difference is that pyramid schemes are somehow different to spot as compared to Ponzi schemes. They are also much protected as the legal teams with groups are more powerful as compared to individuals. One of the biggest examples of Pyramid schemes was Herbalife, a nutritional company that was declared an illegal pyramid scheme and had to pay 200 million dollars for damages but still, it is in business. Its products are in demand, and its stock value is also stable.

Similarities

Both the Pyramid and Ponzi schemes are a type of financial fraud that works by luring clients to invest their money to earn exponential profits.

Both these schemes require new clients (their money) to keep the scam going by paying the old members. These scams don’t invest their own money as naïve people do the job.

In the majority of cases, these scams don’t offer any real product or service and ask for money only.

Both the Ponzi and Pyramid scheme masterminds try to hide their source of income. For this purpose, they use different tactics such as transferring money between different accounts, and in this way, they become involved in money laundering as well.  

Most of the scams lure people by offering high profits, by using moral compasses, or by misusing religions to persuade clients.

In short, the result is the same.

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How to Avoid Being Scammed

As mentioned above, the purpose of writing this article is to educate the readers about scams, particularly the Pyramid and Ponzi schemes, so that they avoid becoming prey to them. As I have told you about these scams, now I will tell you about some precautionary steps that may save your day.

First of all, be logical and rational. Investment opportunities that offer high returns overnight with small investments are impossible and unrealistic. This is more than true when you are investing in something about which you have no prior knowledge. Online trading is a field in which even experienced traders also face losses sometimes, so in these situations, how is it possible for a newbie to earn huge profits on the first try? If it feels unrealistic, then simply don’t go for it.

Secondly, beware of unsought offers. Unexpected and uninvited opportunities, whether short-term or long-term, are mostly scams. Experts always consider them red flags and instruct them to refrain from them.

Thirdly, dig into the seller deeply. The individual or corporation making uninvited offers must be investigated thoroughly and properly before transferring any funds. If the entity is reputable, then it will certainly be registered and observed by regulatory bodies and if not, then stay away from it.

Next, don’t trust blindly or flow with the emotions. Legitimate firms are always registered, so first of all, ask them to provide the registration information. If the firm is not registered, then it should follow a satisfactory explanation. But it is recommended not to accept any explanation and go for a registered entity.

In addition, illegal schemes promise guaranteed profits. This promise cannot be true because all investments possess an element of risk to some extent. If someone is providing a guarantee, he is telling a lie.

Furthermore, try to understand the entity you want to do business with. You should not transfer any funds until or unless you understand it comprehensively. Utilize all available resources for this purpose and turn your back towards it if it keeps the information private.

These schemes usually spread through friends and family members. Your acquaintances might tell you that they have made money through this scam but remember that this is a ploy of scammers because they need to attract more victims to survive.

If the company offers fancy-looking products, it means that it is making it difficult to prove the company is a scam. Take caution is the product being sold has no fixed value.

Nothing is free in this world. If someone offers you money in exchange for doing little work, he may be getting you involved in some illegal pyramid scheme, so you need to become skeptical at once.

Lastly, report the business if you notice something fishy. If you face any pyramid or Ponzi scheme, then you must report it to regulators. This is important because it will save other investors from getting trapped in the future.

The money once lost becomes almost impossible to recover later. So you are advised to take these precautions seriously and don’t step in the mud.

Some Notorious Ponzi Schemes of The Last Century

It is a common perception that wise men learn from the mistakes of other people. For this reason, I am going to share some scams of the previous 3 decades to give you an idea about the intensity of scams.

  • Moneytron

In 1991, Jean Pierre Van Rossem deceived investors through his Moneytron Ponzi scheme, and as a result, people lost more than 800 million dollars. At that time, this was the largest sum lost to fraudulent activity.

  • Caritas

Between the years 1992 and 1993, this company came into the spotlight to help the laymen of Romania, but after some time, it was found that it had stolen more than 1 billion instead of helping people. This was the first instance when con artists had used public sympathy as a tactic to easily gather money.

  • Greater Ministries International
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This was the first instance in history when church leaders were deceived. After using sympathy as a tool, scammers took a step even further and exploited religious persons. As a result, approximately 500 million dollars were swiped. This incident also happened in the 90s, 1997 precisely.

  • European Kings Club

This was a scam that was spread in various European countries, including Germany and Switzerland. It was reported in 1997 that the company’s owner was Damara Berteges, who had deprived people of more than 1 billion dollars of their hard-earned money.

  • MMM’s

As per the reports, this is the biggest scam reported in the 20th century, with estimates suggesting that people lost more than 10 billion dollars to this Ponzi scheme. This scam was executed in late 1994, and it will be remembered for decades to come.

Some Notorious Ponzi Schemes of Modern Century

People were unable to learn from the mistakes of other people, and as a result, more and more scams kept appearing right from the beginning of the 21st century. The lost money to these scams is much more than that lost in the previous century. Some examples are as follows.

  • Bitconnect

This is one of the recently uncovered scams, and it involved Bitcoin. Although the coin itself is not a scam, it was used as a product to lure more customers. The lost money to this scam is about 2.6 billion dollars.

  • Allen Stanford

This 2012 scam was conducted through a bank named ‘Stanford International bank’. The total money lost to the Stanford scam is around 7 billion dollars. This scam affected around 18k investors, and the mastermind behind all this is serving a 110 years prison sentence.

  • Bernie Madoff

This scam was initiated by Bernie Madoff, who is a former chairman of the renowned NASDAQ stock exchange. He managed to loot more than 65 billion dollars, and it is the largest amount lost to any scam in the history of mankind. This scam lasted for several years, but ultimately the scammer was arrested in 2008.

  • Tom Petters

Tom Petters is another scammer who was arrested in the crackdown of 2008. According to reports, he managed to steal 3.65 billion dollars through the scam launched through his firm ‘Petters Company Inc.’

Conclusion

The history of Pyramid and Ponzi schemes stretches to more than 30 years now. A lot of literature is produced about them, but still, they find new victims. The scammers innovate new methods to trap clients every time. It means that it is impossible to stop these scams because greed makes our senses dull. The offers of more than usual profit make people greedy, and as a result, they lose what they already have.

But those people who control their emotions and keep in mind the history of scams and precautions mentioned above manage to evade these scams very easily. So you are advised to thoroughly evaluate the company you want to invest with as in this way the purpose of writing this article will get fulfilled.   


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Hassan Mehmood (Saudi Arabia)

Hassan is currently working as a news reporter for Tokenhell. He is a professional content writer with 2 years of experience. He has a degree in journalism.

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