You often hear stories and jokes about pyramid schemes and Ponzi schemes, but do you know what these actually are and how to spot them? Many people do not know what these schemes involve, which is dangerous because they are on the rise and very serious crimes that could have a significant impact on your finances and life. Keep reading for all that you need to know.
What is a Ponzi Scheme?
First up, you have Ponzi schemes. Essentially, this is a scam that involves paying earlier investors from the funds collected from new investors. This is as opposed to investors gaining returns from legitimate investment profits. Investors believe that the profits are coming from legitimate business activity and are unaware that the money is coming from new investors and the criminal will benefit from charging fees on investments or simply disappearing with investor funds.
The name Ponzi scheme comes from an Italian businessman, Charles Ponzi, who launched a scheme in Boston in the 1920s that guaranteed investors 50% returns on investments. Ponzi made a huge amount of money from the scheme but it fell apart when he was no longer able to pay his initial backers.
What is a Pyramid Scheme?
A pyramid scheme, meanwhile, is a fraudulent business model involving new members joining with the promise of payment with their ability to recruit newer members (creating a pyramid). Similar to a Ponzi scheme, it is the earlier investors that benefit from the funds of subsequent investors and there is rarely any money from legitimate profits (unlike a legitimate multi-level marketing model). These fraudulent business models rarely last long as they grow exponentially and the scheme becomes unsustainable.
Pyramid schemes can be traced back as far as 100 years and have become increasingly sophisticated yet still run into the same issues once the scheme starts to grow exponentially.
Differences & Similarities
It is easy to see why people confuse Ponzi and pyramid schemes as there are some similarities. Both involve earlier participants benefiting from new arrivals and both are usually sustained entirely from illegitimate funding. There are key differences, though, in that victims of a pyramid scheme can often make money from the scheme by recruiting new members. Additionally, pyramid schemes are based on each person bringing in new people while Ponzi schemes are paid for entirely by new investors with the fraudster taking a portion of the money as profit. If you ever fall victim to either scheme – or believe that you have found one – you should seek advice from white-collar defence and investigations solicitors.
It is important to be aware of both Ponzi and pyramid schemes because they are both highly common and can be incredibly dangerous. It can be easy for people to fall victim to these schemes, so you need to understand how they work and how you can spot them.