A money pyramid or pyramid scheme is an unsustainable business model where the initial investors keep all the money and the late entrants absorb all the losses. In this model, the initial investors generate money by recruiting more “investors” instead of selling a product or service.

It is called a “pyramid” because at each new level down, the number of so-called investors increases.

In this model, new investors are asked to make a payment to initiate their enrollment in the “business”. The money the company receives is used to pay the first recruits and investors at the top of the pyramid. Now new members are promised money and profits, if they are able to recruit more people to the bottom of this pyramid.

Sounds simple, doesn’t it? Even promising in some cases. However, that is the idea that the investors at the top want to project. When selling the idea of these pyramid schemes, the model is always sold in a stealthy and discreet way. This is why it is important to familiarize yourself with money pyramids to avoid falling victim to one.

How does a money pyramid work?

These schemes start with an individual at the top of the pyramid. This individual will recruit two people, who are required to make an initial investment to secure their place in this business “opportunity”. This money goes directly to the original recruiter. In order for the new investors to recoup their money and more, they must be able to convince new investors to make the same down payments they did.

The more members a person recruits, the better return on investment the recruiter gets. In many schemes, the money paid by a new recruit is divided among the higher levels in the pyramid.

For example: Level 1 might take 100% of all payments made by people in level 2, 50% of all those in level 3, 25% of all those in level 4, and less and less for each level closer to the bottom.

The basic rule in money pyramids: the more people you recruit, the better you will do.

Why will pyramids always fail?

You do see the problem with this, don’t you? The world’s population is finite, and even more finite is the amount of the population that will agree to invest in these businesses. There comes a point in every money pyramid where the system is no longer sustainable and can no longer grow. That is when one realizes the fraud. Those at the top of the pyramid have generated huge profits while the new recruits end up losing their investment.

Related Reading: 6 money making scams to avoid

Forms that pyramids take

Money pyramids can be camouflaged in various ways to appear attractive to potential victims. There are two main ways in which they appear less obvious at first glance.

(1) Multilevel Marketing

Unlike ordinary pyramids, multilevel marketing is usually legal in its operation. In multilevel marketing, a product or service is marketed that provides some value. New investors help sell products or services and are not required to recruit more people.

However, multi-levels usually give bonuses, discounts or incentives for recruiting more members. In addition, the products marketed by a new member must be paid for by the new member. In other words, the products are not on consignment. Anything that is not sold has already been purchased by the member.

Even worse is when a multilevel handles products that provide little or no value. Holding on to inventory of these types of products is an invitation to lose a lot of money.

(2) Gift Promotions

Some pyramid schemes are disguised as gifts instead of cash advances. These are formed in so-called “investment clubs”. To belong to this club, gifts are given. When someone is recruited, the new recruit gives a gift to the recruiter. The value of the gift will depend from club to club.

Attributes of a pyramid scheme

To avoid becoming a victim of money pyramid schemes, it is important to keep an eye open for the following characteristics:

• No proof of income from sales
• Promises of high profits in a short time and with low investment
• They do not sell any product or service, or at least none that is useful
• Their focus is on recruiting
• They do not want to share with you financial data on their results
• Their income comes entirely from signups or gifts
• You have to pay a large amount to become a distributor of the brand
• They do not allow you to return unsold products

Why do people invest in money pyramids when they know they are destined to fail?

The reality is that there are 3 different types of profiles that participate in these pyramid schemes:

1. Those who know what they are getting into but are overcome by greed
2. Those who are deceived with false promises
3. Those who believe that the products/services being handled are legitimate and useful

Remember, resist the temptation to invest in these schemes just because an acquaintance, family member or social group is promising to generate great wealth in a short period of time.

Hi, I am Nikesh Mehta, owner and writer of this site. I’m an analytics professional and also love writing on finance and related industry. I’ve done online course in Financial Markets and Investment Strategy from Indian School of Business. I can be reached at nikeshmehta@allonmoney.com.