By Larry Wright
The majority of people who invest in Bitcoin and those who take part in Initial Coin Offerings are mainly worried about two things: price and liquidity. First and foremost, there is the Return on Investment that indicates the earnings they will later get from their original investment. Obviously, all investors want positive ROI, but sadly, this isn’t always the case.
Then, there’s another question of worry, which has to do with the level of risk associated with making the investment. It’s much more probable that investors will lose their initial money (in part or in whole) if the risks are too great, which would lead to a negative ROI which is something no one really intends for. Indeed, any investment, by its very nature, has a certain amount of inherent risk. Nevertheless, the danger is significantly raised in circumstances when investors get unintentionally engaged in Ponzi or pyramid scams, which have been banned in the majority of jurisdictions worldwide. As a result, being able to recognize these methods and comprehend how they operate is very important to success.
Investors must be aware about the investments in which they place their money, especially when it comes to Ponzi and pyramid scams. In terms of how they are run, the schemes are relatively similar; nevertheless, there are significant variances in terms of their structure. While a Ponzi scheme is an unambiguous deception, it is feasible for participants in pyramid schemes to make a genuine return on that investment. The most straightforward way to identify the distinctions between Ponzi and pyramid schemes is to look at the definitions, nature, and functioning of each kind of scheme. So, lets dive into it!
What is a Pyramid Scheme?
A pyramid scheme is a kind of financial fraud that takes advantage of the hierarchical structure of network marketing. The Ponzi scheme, possibly the most well-known kind of pyramid scam, is an example of this.
New recruits constitute the foundation of the pyramid and supply the financing, or so-called returns, to the previous investors/recruits who are constructed behind them in the plan. In most cases, a pyramid scheme will not include the sale of items. Instead, it is reliant on a steady input of newly created money investors, which gradually percolates to the pyramid as it grows. As a result, multilevel marketing programs are not considered pyramid schemes as they aren’t really always unethical in nature.
A pyramid scheme is started by a person or a business by enlisting participants with the promise of enormous profits that are promised to them. Even while the scheme’s early participants see high rates of return, these advantages are financed entirely by early investors and do not represent a repayment or profit on any actual investment made by the participants.
From the time the fraud is launched, the liabilities of a pyramid scheme begin to surpass the value of its assets. The only means by which it can develop money is by promising tremendous returns to fresh members, and the only manner these rewards can be repaid is by attracting fresh investors to the company’s ranks. Inevitably, when no one new investors are added to the chain, the momentum behind these schemes’ wanes, and the pyramid comes crashing down.
Another way that pyramid schemes promise fast money is by advertising their goods and services via the use of social networking sites, YouTube videos, internet advertisements, and monetary “presentations,” among other methods of communication. This way they reach out to their potential client base and set a trap for them.
The genuine pitch, on the other hand, is that members may make a lot of money by recruiting people to join them, and they can receive rewards from those who join. The next stratum of recruitment is expected to go outside and bring in even more individuals. With all these investments, the pyramid keeps on rising and rising. In many ways, pyramid schemes are similar to multilevel marketing (MLM) firms, which likewise rely on a chain of recruiting new members to join the organization. Nevertheless, when compared to a legal multilevel marketing company, pyramid marketers place more emphasis on the act of recruiting individuals to sell their products.
When describing what is intended to be the established business for example, e-books, internet advertising, and undisclosed “tech” services, the pyramid scheme’s representatives use ambiguous, fancy-sounding language to deceive customers into buying the products which aren’t necessarily that amazing. Its literally sugar-coating your product in order to manifest your sale, but in a much bad, deceitful way. This “cheating” is the hallmark of pyramid schemes.
What is a Ponzi Scheme?
It is called after Charles Ponzi, the man who invented the scheme and defrauded huge numbers of participants by guaranteeing them a 50 percent or more return on the expenditures in postage stamps and other forms of paper currency. Rather than making any meaningful investments, Ponzi merely stole the cash raised from investors for his own use. The fraud was willing to proceed because he had been able to recruit new investors while still utilizing a part of the money to provide returns to previous investors.
For their part, the earlier investors were expected to assist Ponzi in attracting new investors by talking about the incredible profits they were making while investing with him. After a period of time, however, Ponzi’s business gotten to the point in which he could no longer recruit sufficient small investors to pay out the rising number of prior investors. The hoax was detected at that moment, and it was brought to an end. This is how Ponzi scheme came into being and that’s exactly how it functions even today- new investors are given rewards from the investments of previous clients and the cycle goes on, until new investments are no longer made.
Let’s have a quick overview of how a Ponzi Scheme works.
First, the fraudster entices a customer by guaranteeing him or her enormous rewards on their money. Consider the following scenario: the perpetrator of a Ponzi scheme convinces a first investor to pay him $1 million in exchange for a promise of a 25 percent or greater return on his investment. However, the fraudster does not invest the money that they have received, but instead keeps it all for himself.
Then, the same fraudster is able to recruit a second investor, which contributes an additional $1 million. The fraudster keeps $750,000 of the money and uses $250,000 to give the prior investor his 25 percent “return.” You must take note of the fact that perhaps the investment’s $1 million has not been deposited in anything; nonetheless, the innocent clients think that it has been already deposited and has started generating enormous profits.
The deception may proceed till the schemer is unable to draw in that much new funding to cover “returns” to all of the earlier investors, at which point the scheme is terminated. If, as an illustration, the administrator of a Ponzi scheme has succeeded to recruit 100 investors, each of whom has invested around $1 million, and is drawing in approximately ten potential buyers each month, the operation is considered successful.
Unfortunately, even with all of the funds raised by new investors over the month, there is not enough money to give 25 percent “returns” to the former investors who bought in the first place. As a result, the plan comes crashing down and indeed the deception is exposed. Its literally just a matter of time and nothing else. There’s no one making actual profits here. Its just the wise flow of cash from new buyer to the old one, that everyone gets deceived into believing that Ponzi is actually a healthy investment vehicle, which it is obviously not. In order to increase their profits, Ponzi scheme perpetrators often likewise charge investors massive fees for the (non-existent) management of their assets. You see, its just lies and lies and nothing else at all!
Bernie Madoff is an example of a Ponzi scheme.
Most people are familiar with Bernie Madoff’s Ponzi scam, which was perhaps the most renowned (or notorious) of them all. Over the course of almost two decades, Madoff was able to maintain a Ponzi scheme, robbing shareholders of millions and millions of dollars. By the moment his scheme was discovered, a large part of the proceeds had already been spent and wasted it. As a result, the fact that Madoff was sentenced to jail was of little consolation to his deceived investors.
How Can You Identify a Ponzi or a Pyramid Scheme?
Early identification can help you secure yourself from such disastrous schemes. Here are some ways you can identify a Pyramid Scheme:
- In exchange for recruiting others to the plan, you will get a substantial return, which will rise in proportion to the number of individuals you recruit.
- You will be asked to pay a one-time ‘startup’ deposit as a means of committing yourself to the plan.
- You will be needed to enroll others, and you’ll be compensated for your efforts in this regard.
- Multiple layers of participants participate in the programme, each of whom receives a compensation on a single exchange.
- The plan has not been authorized or recognized as a financial institution with any regulatory authority.
A Ponzi scheme has always been criminal, regardless of the circumstances. Participating in a business endeavor or investment that guarantees great returns in a short amount of time is a scam performed by fraudsters who deceive people into parting with their investment. This strategy makes use of the funds of new capital market participants to provide dividends to existing investors. When recruiting begins to slacken, the plot comes crashing down.
Here’s how you can spot a Ponzi scam when you see one:
- It is claimed that they would provide investors with unusually high investment returns, more than those supplied by traditional institutions (eg 30 percent and more).
- They often provide guarantees about refunds. However, remember, there is never a guarantee of a return. Every investment has some level of risk associated.
- Make certain that you comprehend what you’re participating in, and be skeptical of business plans that seem to be too good or too great. If you are unable to comprehend the company plan, you should refrain from investing.
- The proprietors of the scheme will attempt to coerce you towards investing the money you receive from your profits too as they need these to compensate other investors too.
- Typically, you will be recommended to the plan by relatives or friends who have already earned some income via it. They take advantage of this marketing technique since people prefer to trust their relatives and friends. But keep in mind that they must continue to attract new members in addition to being able to pay more interest to existing members.
By executing transfers from various accounts, Ponzi and pyramid enterprises conceal the real source of cash, and they route the finances via members’ savings accounts so that they’re never being traced back by regulatory authorities. Shareholders are often uninformed that they’re all complicit in money laundering too since they are somehow involved in the whole vicious cycle and they allow their accounts to be used as a means of channeling illicit funds through the system.
Therefore, only put all your money in reputable financial organizations that are authorized with the Financial Services Board and that you would have thoroughly studied, researched and well-reviewed. Always be wise while making an investment!
Ponzi vs. Pyramid: Similarities and Differences
Similarities
- Both are types of financial fraud in which the perpetrators persuade the customers to invest their money by guaranteeing them high returns.
- In order to become successful and promote activity, both organizations need a continual input of fresh investor money.
- In most cases, these programs do not provide genuine items or services.
Differences
Despite the fact that the phrases Ponzi scheme and pyramid scheme are sometimes used interchangeably, there are several significant distinctions between companions:
Payments From a Variety of Sources
When it comes to Ponzi schemes or pyramid schemes, the commitments of early investors serve to counterbalance the expenditures of old participants. Those who participate in a Ponzi scheme feel they are getting returns on their investment, but those who participate in a pyramid scheme understand that they have been trying to make money by bringing in new players to the plan.
Involvement on a Personal Level
Ponzi scheme participants do not remain active in the plan once they have made their first investment. This makes it more difficult for investors to spot a Ponzi scheme in many cases. Because current members are needed to hire young participants to respond to the program, participation in pyramid schemes necessitates a greater level of commitment.
Participating in the Process
Ponzi scheme members often assume they have made a legitimate investment in a legitimate instrument and are completely ignorant that they are a victim of a Ponzi scam. However, individuals are often conscious that they really are important in attracting individuals and that current recruits represent a source of wealth for remaining members.
Time Taken to Collapse
Ponzi schemes, if there are a sufficient number of investors, may typically endure for many years until they are finally brought down. A perfect example of this would be the Ponzi scam run by Bernie Madoff, which lasted more than three decades. Previous pyramid schemes, but at the other hand, have often collapsed swiftly, owing to the fast expansion necessary to keep them afloat.
What You Can Do to Protect Yourself?
- Be wary of chances that come to you without your permission. In most cases, receiving an unannounced request to participate in a long-term opportunity to make money is a warning sign.
- A private equity that promises rapid or large profits with little or no risk is most likely a ruse to defraud investors. This is particularly true when purchasing with something that is completely new to you or that you are having difficulty understanding.
- Make certain that you comprehend the expenditure you would be required to make. It is never a good idea to put your money into something you do not completely understand. Make full use of the information available to you, and exercise extreme caution when dealing with investment offers that are veiled in mystery.
- Conduct a background check on the seller. It is necessary to look into the company that is presenting the investment offer. A competent financial adviser, dealer, or brokerage business will be accredited with and supervised by the appropriate regulating organizations in order to maintain their credibility.
- When consumers come across a pyramid or Ponzi scheme, it is critical that they report the situation to the appropriate people immediately. This will assist in preventing other investors from being victims of the same fraud in the prospective.
Conclusion
Despite the fact that Ponzi schemes as well as pyramid schemes take a different methodology, both concepts are unlawful and almost always end in the loss of money to investors. Each Ponzi scam and pyramid scheme is unique, and as a result, there is no standard on whose basis these operations are made. Therefore, always be conscious and double-check before you finally make an investment.