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Ponzi Scheme vs Pyramid Scheme: Are Both Illegal?


The world of investment is fraught with different types of tools for making money including Ponzi scheme and Pyramid Scheme.

Often the two terms are used as synonyms of each other and used to describe fraudulent investment schemes aimed at making some quick money.

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These are some popular instruments used by scheming fraudsters to swindle money and make quick gains at the expense of unsuspecting investors.

They are both sustained by continuous money flow, and a collapse happens when this source dries up.

Another point of similarity for both is that in both cases only the person who created the scheme is guilty of fraudulent service.

Though, both Ponzi scheme and pyramid scheme share some similarities and are often used interchangeably, there are some striking points of difference as well.

Perhaps one of the most important points of difference between the two is that while some pyramid schemes are legal, the Ponzi scheme is always illegitimate and an outright fraud.

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Ponzi Scheme vs Pyramid Scheme

Ponzi Scheme vs Pyramid SchemeSo, here are the differences between Ponzi and Pyramid Schemes:

1. Product Offering

This is one of the most cardinal differences between one versus another.

Most times, the foundation of a Ponzi scheme is based on a fraudulent investment idea.

In reality, there is absolutely no base or foundation for these schemes and investors contribute on the expectation of very high returns.

The schemer who started the Ponzi essentially uses the money collected from new investors to pay older investors.

There is a single head monitoring this entire money shuffle and keeping a tab on who needs to be paid and whom to take it from.

They become masters of this type of fund transfers and the returns that they promise does not include any real profit.

It is predominantly the movement of money from one account to another.

The pyramid scheme, on the other hand, often has a basic product to offer, and the creator of this scheme creates an opportunity for new investors who earn returns.

If the scheme is genuine, investors can earn via the sale of retail products as well as a commission for getting new investors into the scheme.

It is needless to mention that in case the pyramid is not a genuine one and the schemer has offered a fake product, it essentially uses getting new recruits as the primary bait to attract investors.

Therefore, those at the bottom of the pyramid, help those above them to earn a certain percentage of their sales.

2. Level of Transparency

Between a Ponzi and pyramid scheme, the pyramid scheme is undoubtedly far more explicit versus the Ponzi version.

Right from the beginning, the investor knows that they are paying money to get the opportunity to earn it via recruiting others.

They know it very clearly that the only way to increase their returns is by recruiting more and more people.

In comparison, the Ponzi scheme is one big lie from the beginning.

The very nature of this scheme makes it important to mask the money transfer.

Invariably, this is done by creating a fake legitimate business front, but no business happens on that front.

3. Level of Involvement

The Pyramid scheme invariably needs the participants to work actively towards selling more and more products and also add participants to the scheme for better returns.

Whenever an investor is entering a pyramid scheme, they fully understand this precondition, and in some cases, they even undertake training to learn how to sell this product.

In contrast to this, the investor’s role in a Ponzi scheme is almost non-existent.

All they have to do is just invest and wait for the returns.

The Ponzi owner generally takes a management fee to handle all the related management.

4. Legal Validity

Another factor that clearly distinguishes a ponzi scheme versus pyramid scheme is no doubt the legal aspect of it.

A ponzi is decidedly an illegitimate creation, and there is absolutely no scope of any part of it being legal.

It is absolute deception based on a house of lies.

The pyramid scheme, in contrast, has some element of legal veracity.

At least some companies use a legitimate version of this pyramid to further their firm’s legal validity, and there is absolutely nothing untrue about it.

5. Extent of Deception

In a comparison of Ponzi Scheme Vs Pyramid Scheme, the level of fraud is no doubt much greater in the case of a Ponzi.

The investor gets involved in this type of scheme thinking they are going to earn great returns on the basis of some great investment strategy that the owner of the scheme incorporates.

The investment strategy invariably is the best kept secret of the Ponzi scheme.

In that comparison, the Pyramid scheme is pretty direct in approach.

Investors get into it knowing well that the only way to sustain and clock gains is by recruiting more people and clocking more sales.

The day either or both dry up, their source of sustenance also becomes questionable.

6. Payment Structure

Though both in case of Ponzi Scheme and Pyramid Scheme, the investors are compensated by means of money flow from new investors, those associated with a Ponzi are blissfully unaware of it.

In contrast to this, in a pyramid scheme, the investor knows very well that their earnings are directly dependent on getting fresh investors to the scheme.

Therefore, in many ways, they are prepared for a collapse when the warm circles dry up, or they face difficulty in getting new recruits for the scheme.

Collapse Timeline -In terms of longevity, the Ponzi Scheme undoubtedly lasts much longer than an average pyramid scheme.

Of course, you have some examples of pyramid schemes too that last more than a decade, but in general, a Ponzi finds it much easier to keep getting fresh investors.

In the case of Madoff, we saw the scheme last almost for 30 years.

A typical pyramid scheme generally collapses much earlier, predominantly because of the warm circles getting exhausted.

Therefore, in comparison to the Ponzi Scheme vs Pyramid Scheme, the legal veracity of select pyramid schemes perhaps highlights difference between the two in the most striking manner.

The other factor that makes the difference between the two very clear is the transparency angle.

While the participant in a pyramid scheme knows perfectly well that the returns are always dependent on the new recruits, the level of deception is much greater in a Ponzi scheme.

The hapless investors, in this case, tend to believe that they are earning profits while all that is happening is a mere transfer of funds from one to another.

In a Ponzi scheme, investors don’t have to make money through referring the new investors to the scheme.

They are usually promised to receive a fixed amount of interest every month.

They can also request to liquidate the investment capital and get out of the program.

If they are lucky enough to do it before the scheme collapse, they can receive the capital and walk away.

If not, then they won’t see a cent of their money.

Usually, investors lose all the money they have invested when a Ponzi scheme collapses.

Many of them sometimes lose millions.

But when a Pyramid scheme collapses, the members just lose the money they had invested to advertise and recruit, and also the membership fee they have paid.

The up levels have already made a lot of money and covered their expenses.

Only the lower level members lose the membership fee because usually they don’t have enough time to make some money and recover when they have spent in the program.

In general, pyramid and Ponzi schemes are very different from each other.

Ponzi schemes are a lot riskier and are always illegal while some pyramid schemes can be legal and legitimate.

Something that you have to consider not to get scammed by the Ponzi schemes is that you should avoid investing and participating in any program that looks too good to be true.

A fixed monthly return that looks like a win/win investment for you and a win/loss business for the company, most probably is a scam.

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