PONZI AND PYRAMID SCHEME (all you should know)

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INTRODUCTION

When it comes to investing, the majority of people are worried about two things. First, there's the Return on Investment (ROI), which is the amount of money they'll make after making the first investment. The second factor is the investment's level of risk. Investors are more likely to lose their initial investment (in part or whole) when the risks are too great, resulting in a negative ROI.
Any investment, by definition, entails some level of risk. However, the risk is substantially exacerbated if the investor is unintentionally drawn into Ponzi or pyramid schemes, which are prohibited in most countries. It is therefore critical to be able to recognize these systems and comprehend how they operate.

WHAT IS A PONZI SCHEME

Ponzi scams are named after Charles Ponzi, an Italian con artist who immigrated to North America and made a name for himself with his deceptive money-making plan. Ponzi defrauded hundreds of people in the early 1920s with his over-a-year-long Ponzi scheme. A Ponzi scheme is essentially a deceptive investment scheme that works by repaying older investors with funds raised from new investors. The issue with such a strategy is that backend investors will not be compensated in any way.

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• Let's take a look at an instances

An investor invests $500 in the hands of an investment promoter. At the conclusion of a predetermined period, he agrees to refund the original amount plus a 10% interest rate (e.g., 30 days).

Before the end of the 30-day term, the promoter is able to recruit two additional investors. The $1000 raised from investors two and three will be used to pay $1100 to the first investor. He'll very certainly persuade the first investor to reinvest the $500 as well.

The impostor is able to pay the promised profits to the early investors by obtaining money from new investors, convincing them to reinvest and invite additional individuals.

As the system expands, the promoter will need to recruit additional new investors. He will not be able to pay the promised returns if he does not do so.

The scam eventually becomes unsustainable, and the promoter is either detected or disappears with the funds he has on hand.

WHAT IS A PYRAMID SCHEME

In the business world, a pyramid scheme (or pyramid scam) is a business model that promises compensation or prizes to members who not only join the program but also manage to recruit new members.

A phony promoter, for example, promises Alice and Bob $1000 each to buy distributorship rights in a business. As a result, they now have the authority to sell distributorships on their own, earning a commission for each new member they acquire. The promoter receives a 50/50 cut of the $1000 collected from their own distributorship sales.

To break even in the scenario above, Alice and Bob would need to sell two distributorships apiece. Customers bear the cost of selling two distributorships to recuperate the initial investment. The program eventually falls apart because it requires an increasing number of members to keep going. Pyramid schemes are unlawful because of their inability to continue indefinitely.

Most pyramid scams don't sell anything and rely completely on money earned from new member recruitment to stay afloat. Some pyramid scams, on the other hand, may appear to be a legitimate multi-level marketing (MLM) firm selling a service or product. However, they frequently do so in order to conceal the underlying deception. As a result, many MLM organizations with shady business practices use pyramid models, but not all MLM companies are deceptive.

COMPARISON BETWEEN PONZI & PYRAMID SCHEME

• SIMILARITIES

✅Both are financial fraud that promises mouth-watering good returns.

✅They need a constant flow of new fresh investments in other to keep functioning.

✅Both ponzi and pyramid schemes do not offer any tangible or real products but are based on falsehood and unreal assets.

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• DIFFERENCES

✅Ponzi scheme is built on false investment management. Victims are usually made to believe that their capital are being invested on a real project or asset which yields returns whereas the fraudsters are basically robbing Peter to pay Paul.

✅ On the other hand, Pyramid schemes are based purely on marketing. Whereby members are required to pull in fresh investors and earn a commission from them while the rest of their investment goes to the system owners.

HOW TO PROTECT YOURSELF FROM PONZI

✅Maintain skepticism. An investment offer that promises fast or big returns for a small investment is likely to be deceptive. This is particularly true when investing in something completely new or difficult to comprehend.

✅Unsolicited opportunities should be avoided. A sudden request to join a long-term investment opportunity is usually a warning sign.

✅Examine the vendor's credentials. It's a good idea to look into the company that is offering the investment opportunity. The appropriate governing organizations will register and oversee a trustworthy financial advisor, broker, or brokerage firm.

✅Don't put your faith in anything. Verify. Investments that are lawful should be registered. Asking for registration information is the first step. A good and fair explanation should be given if the investment opportunity is not registered.

✅Make sure you know what you're getting into. Never put money into something you don't completely understand. Make the most of the resources available to you, and be skeptical of investment opportunities that are veiled in secrecy.

✅Report. When investors come across a pyramid or Ponzi scam, they should report it to the appropriate authorities. This will assist to safeguard future investors from falling prey to the same scam.

CONCLUSION

Having seen and understood what ponzi and pyramid schemes are and the dangers involved, it is best adviced for us to always be mindful of the kind of investments we make. As we have seen, most of these schemes offers mouth-watering opportunities of which if one isn't careful, one will fall them it.

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