Ponzi and Pyramid Schemes: How They Work and Why They Collapse
Early investors get paid with money from new ones, until the new money runs out. How Ponzi and pyramid schemes work, how to tell them apart, and the signs to watch for.
Ponzi and pyramid schemes promise steady, high returns. For a while they deliver, which is what makes them so convincing. But the "returns" are just other people's money moving up the chain, and the collapse is built in from the start.
How a Ponzi scheme works
- An organiser promises high, reliable returns from trading, crypto, farming or property.
- Early investors receive payouts, funded by later investors' deposits.
- Word spreads; more money comes in.
- When new money slows, withdrawals are delayed, "fees" appear, and the scheme stops paying. See when a scheme stops paying.
How a pyramid scheme works
- You pay to join, then earn by recruiting others who pay to join.
- Little or no real product is sold to real customers.
- Each level needs more recruits than the last, which becomes impossible. See pyramid recruitment on WhatsApp.
Warning signs
- High returns with little or no risk. See "guaranteed returns".
- Consistent returns regardless of market conditions.
- Unregistered sellers or firms. See checking an investment licence.
- Secretive or complicated strategies.
- Difficulty withdrawing money.
- Rewards for recruiting.
If returns depend on new members joining, it will collapse. The only question is when.
For more, see investment scams.
Frequently asked questions
What is the difference between a Ponzi and a pyramid scheme?
In a Ponzi scheme, an organiser pays earlier investors with newer investors' money and claims it is profit. In a pyramid scheme, participants earn mainly by recruiting others who pay to join.
People I know were paid. Doesn't that prove it works?
Early payouts are how these schemes attract new money. They stop when new money slows.
Why do they always collapse?
They need ever more new money to pay existing members. Eventually recruitment slows and there is not enough to pay everyone.
Sources
- Ponzi Scheme, Investor.gov (US SEC)
- Pyramid Schemes, Investor.gov (US SEC)
- Multi-Level Marketing Businesses and Pyramid Schemes, US Federal Trade Commission
