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What Is a Pyramid Scheme in Simple Words?


If you are curious to know what a pyramid scheme is, it is a marketing model.

Businesses undertake various initiatives to attract customers & drive growth.

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The pyramid scheme is one scheme that thrives on people joining.

It is a chain of followers ever expanding.

This is how the name Pyramid came into being.

Of course, there is a monetary angle to it as well.

After all, that is how the pyramid grows eventually.

Just like in a pyramid, it starts with one person and keeps growing in size.

Every new member who has joined needs to pay a certain amount.

Then the already existing members will get this money.

This is how the members of a pyramid make money.

But somehow the mention of Pyramid brings names like Madoff to the forefront.

That sure makes you uncomfortable.

You worry about the authenticity, the relevance of schemes like it.

Should you go ahead and join one?

Or, is it better to stay away from them?

Well, it is all mired in a sea of indecision.

Perhaps the most important aspect is to understand the concept well.

You have to understand how it is made and how it works?

That will help you understand the concept succinctly.

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What Is a Pyramid Scheme?

Perhaps this is the primary question.

How exactly do you define a pyramid scheme?

Or what is a pyramid scheme?

It is essentially recruitment of members in exchange for monetary compensation.

Basically, if you want to get paid, you recruit people.

The more the number of people you recruit, the higher is the payout.

But the problem is most times, these pyramids face pyramid issues.

Pyramid SchemeThat is they get bottom heavy.

As a result, it becomes unmanageable.

The result, the pyramid comes crashing down all at once.

This is exactly where all doubts and questions have been raised about a pyramid’s legality.

But you must remember that the pyramid does not make money by selling a product.

The money transfer is what keeps these pyramids going.

So, once the chain becomes difficult to handle, the pyramid collapses.

Almost like a pack of card, it comes crashing down.

But, at the same time, pyramids also are a reflection of the human nature to make money.

These are nothing new.

These pyramid schemes have survived centuries.

Bernie Madoff did not create a unique product.

There are many anecdotal references of such pyramids in the last century.

In fact, one of the most common marketing methods is an extension of this scheme.

– Multi-Level Marketing

It is called multi-level marketing.

There are many companies globally who are distributing products through MLM.

They are also using MLM to their advantage making money from it.

But the hard part is pyramids are unsustainable over an extended period.

As the chains keep expanding, keeping track becomes all the more difficult.

Eventually, the market also starts saturating.

You find it that much hard to find new members.

The result, as new members stop joining, the money flow gets impacted.

Finally, the scheme falls apart.

There are some legal MLM programs.

But Pyramid Schemes are always illegal.

Understanding a Pyramid Scheme

So what is the basic concept that is driving Pyramid Scheme?

In this case, an organization forces a new member to pay to join the scheme.

The incentive is they will also get money once they recruit someone.

Every member receives a reasonable share of money from the new joinee.

If you are right at the top of the pyramid, it can be an attractive proposition.

Whoever gets whatever number of recruits, they are sure to benefit from it.

So, the organization manages to create a pretty dependable revenue stream.

What is particularly striking is all of this without selling or manufacturing any product.

The only way this money will continue is to bring more people in and generate more revenue.

The rate of growth is also similar to that of geometric progression in mathematics.

Every new chain is significantly larger than the previous one.

This geometric expansion alone can enable adequate revenue flow to sustain it.

But, this does not continue for an infinite number of years.

Once you stop getting any more recruits ready to join the organization, it begins to collapse.

Therefore, those at the top of the pyramid scheme benefit the most.

The bottom layer typically suffers the most in this case.

They pay the most but get zero to no returns.

So, you will notice that the old members in the system tend to make relatively large sums of money.

Almost every new member is keen to get recruits to recover their investment.

Getting new members almost becomes a compulsion.

In fact, that is the only possible way to mobilize funds.

The members join in the hope that they will be able to increase their money quickly.

What they don’t come prepared is the legwork involved in getting new members.

Different Types of Pyramid Schemes

1. The 15-Member Eight Ball Model

One of the most popular types of the pyramid scheme is the eight ball model.

In this case, each member recruits two members each.

So as the chain progresses to net 4 lines, you have 15 members.

Usually, the amount required to join these is relatively large.

What is even more worrying is the one at the top tends to be in a win-all situation.

However, if the plan collapses, the bottom three layers could lose money.

But, those at the top tend to make large sums.

Those at the top of the pyramid can also look to withdraw the pyramid and again join back.

In this way, they can expect a second payout eventually.

So, those at the top of the channel can choose to record significant gains.

However, those at the bottom have to continue trying to get more members.

That is the only way they can hope to get their money back.

If the scheme collapses in the meanwhile, they tend to lose the entire money.

This means that if you want to scam members, you can easily do so.

The biggest losers are the ones at the bottom.

2. The Matrix Scheme

This is a relatively non-sustainable variant of what is a pyramid scheme.

This is also a point where it borders close to scam levels.

In this case, a desirable opportunity, product or payout is at stake.

But the problem is only a select list of members would get it.

As this matrix progresses in geometric progression, the end is imminent.

Normally, in this case, you also have a material gift waiting.

That is given in order of seniority.

So, the one at the top would get it for sure.

But, those at the bottom may not get an opportunity before it collapses.

The gifts comprise of relatively expensive options like TV, camcorder and the like.

Many regulators have termed the Matrix system illegal.

This is cardinally because of the lottery like features.

The argument often points towards the unpredictability of the scheme.

It refers to the uncertainty aspect as well.

This is exactly why many countries have clearly marked these pyramids as illegal.

Just like any other pyramid, it also collapses when no one else is interested.

This means those at the top will stand to gain in all situations.

However, those at the bottom invariably tend to lose large investments.

How Does a Pyramid Progress?

So that brings us to a closer study of what is a pyramid?

The key here is to understand how the pyramid works.

In a sense, why would anyone join the pyramid?

Well, most times, they get an offer that they are unable to deny.

Or, the offer might be so attractive that they feel compelled to join.

Greed is, most times, the most important sentiment driving these pyramids.

It is almost human to want to make more money.

Not just that, you want to make money in a hurry.

This is exactly how a pyramid progresses.

Let me use an example, to explain my point to you.

Let’s assume I have X product that would want to sell.

I create a starter kit for this to entice people to join me.

Now I woo about 10 people to pay me $100 each for the starter kit.

I promise them they can recover the same by selling to other recruits.

I decide each one should sell it to 10 more.

My share from each new recruit would be 10.

Now my first set of recruits have already put in $100 each.

So now they are compelled to sell more to recover the $100.

But then they are told the easiest way to recover money is by getting more recruits.

So they contact all their acquaintances, friends, family and relatives.

The idea is to get as many people on board as possible.

The result, people realize the pyramid’s true nature eventually.

So, getting fresh recruits keeps getting more and more difficult.

Consequently, you reach a stage, where no one else agrees.

This is when the pyramid begins to collapse.

Those at the top have already benefitted, but those at the bottom suffer.

The Mathematical Improbability

If you undertake a closer study of pyramids, it is often considered a mathematical impossibility.

The pyramid progresses in geometric level.

That means that the gains are skewed towards a select chain.

Not everyone can gain from it.

Statistics indicate that nearly 90% of the members tend to be at the bottom of the pyramid.

This means that this is also the number of people who are more likely to lose their investment.

If it is a straightforward pyramid, the rate of losers could be even closer to 91%.

But the scope of losses increases even more in product based pyramids.

In many ways, more the amount of money at stake, bigger is the risk.

As a result, the scope of loss in product based pyramid is almost 99%.

So in many ways, those at the bottom of these product pyramids almost never get their money.

This means that the only gainers, in this case, are the ones at the top who start off the pyramid.

Their gains are as guaranteed as the loss of those at the bottom.

This is the reason why questions are raised about the credibility of pyramid schemes.

This is also the reason that many variants of the scheme are considered illegal in many countries.

Multi-Level Marketing Schemes

In this context, there is one more pyramid scheme that is worth discussing.

This is the multi-level marketing scheme.

More than a direct marketing strategy, members can earn two ways from these.

On the one hand, they are promoting a product and making money from it.

They sell the product to customers and earn commission on the sale.

But this is only one aspect of it.

There is also another channel to make money from this arrangement.

They can also recruit new members and earn a percentage on their sale.

Perhaps one of the simplest examples of this kind of pyramid is direct marketing firms.

Whether you consider the likes of Avon, Amway or many others, this is how they operate.

They are also the legal kind of pyramid schemes.

However, you must remember that the overall income potential in these schemes is fairly limited.

Don’t think you can make a fortune with them.

Most times, the earnings percentage is quite meager.

Nevertheless, these are the credible type of pyramid schemes.

The only problem in these is you put in a lot of effort, but returns are limited.

Though, it is fairly difficult for these to collapse, growth does stagnate here too.

Beyond a point, the warm circles get saturated.

By this, I mean you run out of people to sell your products.

Similarly, the number of people ready to join the pyramid also dwindles.

Therefore, the earnings potential also reduces significantly.

That means, here again, the scope of recovering your investment keeps reducing.

Unless you can sell products aggressively for a sustained period, you cannot make money.

Eventually, these too meet the same end as another pyramid.

Many at the bottom quit without recovering their investment.

Are Pyramid Schemes Illegal?

That brings us to the primary question, are these illegal?

Apart from multi-level marketing schemes, most others tend to collapse.

Thus, does it mean that they are all prone to being illegal?

Yes, the legality of a pyramid scheme is a primary concern in most countries.

Well, the fact is if your pyramid is progressing as a gifting club, it could be legal.

The Ponzi is definitely the illegal end of the pyramids.

In fact, most times windfall earnings come under the Government scanner.

Their credibility needs to be questioned, and this is how you can define their authenticity.

In this context, the chain letters are also not exactly illegal on their own.

But the moment there is an investment provision in place, questions are raised.

The legality of the scheme also comes under the scanner.

Though, per letter cost could be as low as 5 cents, there is no way to recover.

Investors, who get swayed by these chain letters, end up losing this money.

In this context, they gain on volumes.

Moreover, most people would not worry about losing 5 cents.

But the problem arises when they start recording a steady stream of losses.

Perhaps the Ponzi schemes are the out rightly illegal ones.

They’ve got the name from the notorious schemer Charles Ponzi.

This is a completely fraudulent dealing.

One person creates this scheme primarily with the objective of a scam.

People get in on tall promises.

By the time, they realize that they won’t get their principal, it is quite late.

They have lost their money and are literally in trouble.

As you saw in case of Charles Ponzi, beyond a point, the scammer simply wrapped up operations.

What is worrying is most times the investors don’t even know who the founder is.

Therefore…

Avoid Getting into a Pyramid

This is exactly why it is important to know how to avoid getting into a pyramid.

When you hear a sales pitch for one, don’t get buoyed easily.

Don’t ever let your greed get in the way.

The promise of making quick bucks is always interesting.

But, you must remember that this is also a dangerous trap.

You must always undertake in-depth research.

Only then, you can be sure about the exact mettle of the investment option.

Don’t just let someone convince you on the basis of some strategy talk.

Be your own judge.

Take a decision on your own.

Think about the authenticity of the program.

Check the organization’s authenticity.

If possible, try and verify the credibility of the scheme from other members.

Therefore, before you join one, always look for details of the pyramid scheme.

That will help preserve your investment and not fall prey to pyramid scheme scammers.

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