I know the term but I’ve never actually been able to understand what it is and what happens in one
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Jimmy buys a bunch of candy from you. He then finds five friends and sells them candy, then gives you some of the money. Then those five friends sell their candy, give Jimmy some of the money they earn, and then Jimmy gives you some too. And so on.
At it’s most basic idea a pyramid scheme is one where there’s no “real” customers just sellers who sell to sellers who sell to sellers.
I (at the top of the pyramid) sell something to you that you are going to sell to someone else. I convince you that this is a good idea and that other people are really going to want this thing, so you buy a bunch of it intending to sell it to other people. But instead of finding real customers you just recruit someone else to sell the product for you, and they do the exact same thing. All the way down to the bottom where some schmuck buys a thing that they don’t really want to use thinking that they’ll be able to sell it to someone else only they can’t so it just sits there.
In a modern context there are sometimes some customers involved who actually do use the product, but the vast majority of the “buyers” of the product are people intending to sell the product to someone else.
Pyramid schemes involve a “business” opportunity that relies on drawing in new investors.
Basically, I have a business opportunity for you. You give me $100 to get in. I tell you that to make money you have to get 10 people to buy in. They give you $100 each, you give me $80 from the $100 you get from each person. I make $900, you make $100. You tell them the same thing. They each find someone to buy in. Those people keep $10 of the $100, you keep a share, then pass me my share.
The bulk of the money keeps getting funneled up. The early levels can make massive amounts of money, but the later you get in on the scheme the more likely you are to end up holding nothing. The “business” isn’t really producing anything or offering a legitimate service. It’s just taking money from new “investors” and funneling it up the higher levels.
Multi-level marketing is a type of pyramid scheme, but it gets around the law by having an actual product that sold. It just requires new “investors” to buy the product they intend to sell instead of buying a share of the company.
Answer: The original pyramid schemes were investment schemes. You invest $100, then you are required to recruit 6 friends who invest $100 each. The person who recruited you gets the $100 from your recruits. You get the $100 from the people who are recruited by the people you recruited. Theoretically you get $3,600. Except for this thing to get 10 levels deep you need 1.5m people. To get 13 levels deep you need 13bn. That’s more than there are people on earth.
However, the term pyramid scheme isn’t just used for this. Various scams that, at their core, are similar to this are also called pyramid schemes.
The key elements are: participants make money by recruiting people, and those people recruiting other people; little/no money comes into the scheme from people who are not participants; and it is mathematically impossible for everyone participating to get the kind of return/income they expect to achieve without endless recruiting that simply cannot occur due to running out of people.
The most common type seen today is multi level marketing. This is where you disguise the scheme in a business that is supposedly “direct selling”. Participants sell products and can make money doing so. However, almost no-one can make a decent income selling products to end customers. The real money is made by recruiting, and selling products to those recruits who are aiming to sell the product on, not to use it as a customer.
In many countries, including the US and UK, multi level marketing is legal. The schemes do everything they can to stay on the right side of the law and make a lot of money for their founders and some lucky early participants.
The simplest pyramid scheme involves getting money from people in return for nothing of value. So I go to 10 people and give them a speech: “All of you, give me $10, and then you all go find 10 more people each, and give them this same speech. Everyone who successfully does this will wind up being $90 richer. But it ONLY WORKS if everybody actually gives the $10.”
I get $100 from them. They each get $100 from their various victims. And so on. But it can’t go on forever, because eventually you run out of people for them to recruit. So it’s illegal, because it always results in a bunch of people getting screwed. Economies have collapsed because of this scam.
So to get around the law, what people do it try to disguise it as a sales thing. I don’t just tell you to GIVE me $10, I get a few pennies worth of cheap merchandise, and I SELL it to you. And I tell you to go out and recruit more people, who will in turn buy from you. Your job is to sell cheap merchandise, and at the same time, recruit new people to sell more of it.
But at the end of the day, the actual product is just an excuse- nobody actually wants the stuff, you can get that in a store. The point is that I’m getting a bunch of suckers to give me some money and recruit new suckers- just like in the original scheme. Except it’s not quite illegal now, because we’re pretending we’re selling stuff, rather than just handing over money.
It’s a “pyramid” because the structure resembles a pyramid or “tree” diagram.
The concept is “robbing peter to pay paul”; you pay off early “investors” with the investment of later “investors”. So long as you have enough new “investors” to pay off older ones, things work… but the ‘pyramid’ part means you can’t do that forever, because the model requires infinite growth.
The idea is that the group running the scheme get people interested with large returns… but that requires many pay-ins for one pay-out (especially after the people running the scam skim some off the top for themselves). There’s a version called a “blessing circle” or something that makes a good example; what it boils down to is that you pay in $1000, and once you have 8 people ‘downstream’ who have paid in $1000, you get $7000 (with the 8th $1000 going to the organizers). This “success” makes the scheme look legit, making it easier to bring more people into the scam.
But now those 8 people need to each find 8 suckers of their own, meaning 64 people need to be brought in for the next ‘layer’ up to get paid. And 64 people requires 512 suckers to get paid, 512 needs 4096, and so on. Eventually there simply aren’t enough suckers left, and the late-comers have bought in for $1000 and never get paid.
It’s a pyramid because if you draw a diagram connecting each cohort, with the first person as the top, then their 8 followers as the next layer, and so on, it resembles a pyramid (moreso if you use a smaller number of people per new layer).
It’s a type of a non sustainable business model.
Whereas a classic business model relies on creating value for its customers in return for profit, a pyramid scheme doesn’t create any value at all. It pretends to create value by giving its customers money it takes from other customers (whom it promised to pay as well from other customers and so on).
Most people understand that it will never be able to work in the long run but are hopeful to “quit while they are ahead” dumping the losses on fellow customers (investors). What actually statistically ends up happening though is the vast majority of people involved lose all of their money.
It goes like this:
Person A recruits two people — call them “B” and “C” — into a “unique business opportunity.”
B and C pay A $20 each. They each agree to recruit two more people. Each of the people they recruit have to pay $20 – half goes to the recruiter and half goes to A.
B recruits D and E. C recruits F and G.
The four newest recruits all kick in $20. Now B and C have made their money back, and A has $80.
The business is only sustainable as long as you continue to add people at the bottom.
Inevitably, it falls apart. A, B and C have made a bunch of money by that point, but the last group in never gets a return on their “investment.”
Suppose I say to you “Give me £10, and I’ll double your money in a week.” You decide it’s only £10 and I’ve got great hair, so you trust me enough. You give me the £10. A week later, I return with £20 for you. You don’t know what I’ve done, but it’s worked. I then ask you to tell a few other people about how I doubled your investment. Well, now I’ve still got great hair, and you’ve got an extra £10, so you’re happy to oblige.
What you don’t realise is that I just found another 2 people who liked my hair and “invested” £10 each. With the now £30 that I’ve got, I went back to you, gave you £20, and pocketed the remaining £10.
Now that I’ve convinced you it works, I can use you as a witness to help me get £10 from another 5 people. I take this £50, use £40 of it to pay back my second group, and pocket the remaining £10. Now you’re up £10, as are the second group, and I’m up £20. Except I now owe 5 people £20.
So, I use you and the other two happy customers as character witnesses, and politely ask another 12 or so folk for £10. I can use £100 of that to pay back the other 5 people and pocket £20. Maybe I slip you three a couple of quid for helping me. So, I’m up about £40, but I now owe £240.
At each stage, everyone seems to be happy with their profit, and I keep earning a little bit. But, we need to recruit more and more people for it to keep working, at least doubling at every stage. It keeps growing wider and wider, like a pyramid. Eventually, I’m going to run out of new investors. Then, I’ll just be in a huge pile of debt, or hiding on an island!
Pyramid schemes both refer to legally legitimate businesses that rely on signing up new members and obligate them to buy inventory from the owner of the corporation and sell it for them (which is typically predicated on some kind of high pressures sales tactics or dishonesty) and etc, and also to what are now referred to as Ponzi schemes, where an individual or organization defrauds investors/customers by promising some kind of valuable investment service that doesnt exist, and sustains their magic trick by continuing to attract clients.
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