1. What is a Pyramid Scheme?
A pyramid scheme is an illegal investment program which pays extremely high returns to earlier members of the scheme with money acquired from new members.
A typical pyramid scheme has a business model that works like a club or a community organisation, except that most members of the scheme do not know each other personally or otherwise; mainly because the number of people involved with a single pyramid scheme can run into thousands of people.
New recruits contribute a certain amount of money to the scheme, the amount contributed depends on the rules of the scheme. The contributed money is paid to other members who joined the scheme earlier. New recruits pay the money with the belief that they themselves will be paid further down the line when other new members are recruited.
Unfortunately, the number of people at the bottom of the pyramid required to sustain payments to the top members who joined earlier increase exponentially as the pyramid scheme grows. As a result the scheme’s funds will diminish at some point when the number of new recruits start dwindling.
Eventually, new members will dry out and payments to people at the top of the pyramid will stop, resulting in the scheme's collapse.
2. How Pyramid Schemes Work
Pyramid schemes come in different shapes and sizes but their basic structure is the same.
A basic pyramid scheme starts off with a single individual on top (Level 1) of the pyramid scheme – let’s call this individual Mr ‘A’.
· Mr A recruits 2 friends on Level 2 – Mr B and Mr C.
· Mr B and Mr C pay Mr A $100 each, so Mr A receives $200 profit. He then drops out of the pyramid system.
· Mr B recruits 2 people to Level 3, Mr D and Mr E who each pay Mr B $100 each, so Mr B has $100 profit before dropping out of the pyramid as well.
· Mr C also recruits 2 people to Level 3, Mr F and Mr G who each pay Mr C $100 each, so Mr C has $100 profit as well before dropping out.
· Mr D, E, F and G also recruit 2 members each to Level 4, making $100 profit and dropping out. The process is repeated over and over again. Those who joined earlier and received payments and dropped out are allowed to start from the bottom of the pyramid again if they so wish.
As you can see Level 1 started with 1 member, Level 4 already has 8 members. Level 5 will have 16 members, Level 6 will have 32 members and so on. By Level 24, the number people required to be members of the scheme to sustain it would be 16 million, which is more than the working population (15.1 million) of South Africa. Obviously, the scheme will collapse way before it reaches Level 24.
The levels of the scheme form a pyramid like structure as per the diagram above, hence the name pyramid scheme. The scheme continues to operate until people at the bottom of the pyramid fail to recruit new members, then the scheme collapses. When the scheme collapses, all the participants at the bottom of the pyramid will lose their contribution. With this basic and simple pyramid, at least 50% of the participants will lose money.
All the pyramid schemes are based on the above basic model, but in practise pyramid scheme operators use complex variations of the model.
An example of a more common type of pyramid scheme model used by many scammers is called the EightBall model.
· This model starts off with Mr A on level as the captain.
· Mr A invites 2 of his friends to be below him on level 2.
· Two of his friends each invite 2 people to be below them on level 3.
· So, now with this total of 7 people, the basic structure of the EightBall pyramid scheme has been established. At this point it is up to Mr A to decide if the 6 invited people pay anything or not.
· The seven participants help each other to invite a total of 8 members to be on level 4 below. The eight members are required to each pay the person on top of the pyramid, Mr A, $100.
· Note that the group of 8 participants on level 4 have paid Mr A, also know as Captain he is on level 1. So Mr A receives a total of $ 800 and drop out of the pyramid scheme.
· The pyramid is then divided in half and split into 2 groups of 7 people each, allowing each member to rise a single level up. Each of the groups will have a new Captain.
· The 2 groups will repeat the cycle all over again by inviting 8 new people who will pay the groups Captain $100 each, allowing the group to split and elevate each member of the group to rise a level up.
The cycle will duplicate and repeat itself over and over again until the pyramid scheme is unable to recruit new members. Realise that another level is added each time there is split in the pyramid. Each split or level requires 8 new people just to pay one person who is at the top of the pyramid, the Captain.
By Level 24 the scheme will require at least 16 million members to have joined scheme to keep going. Pyramid schemes require an exponential growing number of new members to continually join to keep going. Therefore pyramid schemes will work as long as they attract a lot new members. Attracting new members is not easy as most people know that pyramid schemes are illegal and others can see that the odds of success are stack against them.
Unfortunately, there is no business that can sustain itself based on attracting new members all the time. Eventually new members will run out, when that happens, the whole system will collapse and the people at the bottom of the pyramid will lose out.
Pyramid schemes use many variations of this system whether they are product based, time based or naked pyramid systems.
3. Type of Pyramid Schemes
Pyramid schemes come in all forms and sizes and, and a result, there many variations of pyramid schemes.
a. Hidden Pyramid Schemes
Some business models hide their pyramid-based operations by selling poor quality or overpriced products or services. It is extremely difficult to sell these products to members of the general public because they offer very little value for money. As a result, the merchandise or services are usually sold to and bought by members of the scheme only.
Empower Network, Amway, and Karatbars are all hidden pyramid schemes because their products are overpriced and are primarily bought by members or people who become members of those businesses. Members are rewarded much more for recruiting new people than for selling the actual product.
The sad thing about these type of businesses is that members are not aware that they are in a pyramid scheme, only top leaders have a clear view of the pyramid. Only about 1% of members make a reasonable profit in this scheme, the rest are losing money or just surviving. Unfortunately, this type of pyramid scheme is legal simply because products are being sold. Moreover, these type of pyramid schemes can survive for a very long time as people at the bottom of the pyramid earn nothing or very little while the big bosses get a big chunk of the bonuses.
b. Naked Pyramid Schemes
Naked pyramid schemes make it clear to its members that they are not investing funds or operating a business. They make it clear that money comes from existing community members and new recruits. The now defunct Kipi Mydeposit241, the dying MMM RSA, the dead Malwande and UplifingSA; the still alive and kicking (at the time of writing) Zewang and Kept Funds are all good examples of naked pyramid schemes. But rest assured that both Zewang and Keptfund will soon bite the dust as well. So don't go there rushing to invest or donate.
c. Recruitment Based Pyramid Schemes
Old generation pyramid schemes required each member of the scheme to recruit new members to be compensated and grow the pyramid. Those members of the scheme who were not able to personally introduce members to the scheme would leave the scheme empty handed.
Remember, it was before the internet, and social media became popular. So these schemes relied on a word of mouth to spread their message and promote the schemes. But even with today's social media that makes it easier to spread the message, recruitment based pyramid schemes are still around. The Rich Society, Four Corners Alliance Group, and many others are recruitment based pyramid schemes.
Product based pyramid schemes such as Amway require each member to promote the schemes products by recruiting new members, and hence are recruitment based as well.
d. Time-Based Pyramid Schemes
These days, the majority of pyramid schemes make it optional for members to recruit. Members are remunerated for contributing funds to the system and keeping it there for a while. The returns vary for different schemes. Some pay interest as little as 15% per month while others pay anything from 30% to 100% or more per month.
The higher the amount a member contributes, the higher the returns. However, investing heavily in a pyramid scheme increases the severity of loss.
Though recruiting is optional, members are incentivized to do it. Members with network marketing skills benefit the most as they are handsomely rewarded for bringing in new members into the system.
Many people are attracted to this type pyramid scheme because they don’t have to do any recruitment work on their part. This is because the majority of people in this type of pyramid scheme are invited by promoters who are skilled at group psychology.
Out of all types of pyramid schemes, this is the most dangerous in my opinion as the members tend to contribute huge amounts of money. People go as far as taking up bank loans and using their savings or retirement funds just to invest in a pyramid scheme. It is not a wise move to do like the chances of losing money in these schemes are extremely high. In the end, an overwhelming number of investors lose out in this type of pyramid scheme.
4. Pyramid Scheme Funds Storage
a. Pyramid Schemes with a Central Bank Account
In this type of pyramid scheme, the money is paid into the central account of the organization. The scheme's administrator is responsible for managing the bank account as well as accepting and disbursing payments to members.
These types of pyramid schemes tend to have an added level of risk because, in addition to the standard risk of money running out due to new members drying out, there is a risk that the financial institution can shut down the bank account, or even worse, the administrator can defraud investors by simply transferring all the funds to his personal or business accounts.
b. Pyramid Schemes without a Central Bank Account
These type of schemes are very common these days where the money is not kept in a scheme's bank account. Instead, an ingenious system is devised where the funds are kept in members’ personal bank accounts.
Many pyramid scheme participants prefer this system of storing money as it makes it impossible for banks to freeze the schemes funds. They also believe that it also make it somewhat difficult for the scheme administrators to defraud them.
However, this type of scheme is deadly as it creates a false sense of security in members mind. In reality, nothing stops the schemes administrator from having multiple bank accounts for himself and his family and then directing funds of the unsuspecting member’s funds to those accounts.
5. Who Owns Pyramid Schemes?
Pyramid scheme owners always deny that their organizations are pyramid schemes. Instead, they claim that they are mutual help organizations belonging to the community or members of the scheme.
Owners claim to create them with the intention to genuinely contribute to improving people’s financial lives. However, their intentions don’t matter because the result is always the same, the scheme eventually collapses, and a whole lot of people are left with anguish as they lose a lot of money.
In reality, many pyramid scheme owners create them with the intention to make themselves multimillionaires. Indeed pyramid owners and administrators are professional conmen and scammers who have become very rich.
Most pyramid schemes are run by people who do not care about the other participants. They know that a vast majority of participants will lose money, but since their motivation is greed, that doesn’t stop them.
6. Why Pyramid Schemes are Illegal
Pyramid schemes are illegal because they are not sustainable and are bound to result in the vast majority of participants losing money.
By their nature, a pyramid scheme is designed to generate false returns for owners and those who join earlier, but pain and suffering for those who join the party late.
Pyramid schemes appeal to people’s greed, the promise of huge rewards with payments to few members who joined early make pyramid schemes very attractive to uninformed members of the public.
7. Participants' Failure Rate
A pyramid scheme works well for only a very small number of participants at the top or start of the pyramid.
Calculations show that in a typical naked and personal recruitment based pyramid scheme where 8 members pay $ 1 000 each to a top member who recruited them, 88% of participants at the bottom of the pyramid lose money. Research shows that in a product based pyramid scheme about 99% of participants become losers.
Although the chances of making money are stacked against the participant, people still join pyramid schemes with the hope that they will be amongst the first to join a new pyramid scheme. However, being one of the first people to join a new pyramid scheme does not guarantee success.
What people don’t realize is that just because a pyramid scheme is new does not mean that it will be marketed well and grow. Some pyramid scheme dies at the infant stages. Moreover, generally speaking, pyramid scheme administrators are con artists who don't care about members' interest. They just care about filling their own pockets.
Perhaps the best way to guarantee that you make money from a pyramid scheme is to start your pyramid scheme. With the advance in technology, pyramid scheme software is readily available from unscrupulous software developers. This explains the recent proliferation of pyramid schemes all over the internet targeting developing countries.
These days, any Tom, Dick and Harry can start their online pyramid scheme. However, note that running a pyramid scheme is not only unethical, but it is also illegal. Though most people who run pyramid schemes seem to get away with it, you may be one of the unlucky few ones and find yourself in