What the Concept of a Pyramid Scheme is and How Basic Models Are Executed

Pyramid schemes have existed worldwide for over a century (source: wikipedia.org). The perpetrator of a pyramid scheme will rely on individuals that are both greedy and gullible. Spotting these types of scams can sometimes be a challenge, but knowing the concept of these illegal businesses and how the basic models work can help keep you from falling victim to one.

The most basic model of a pyramid scheme is to get an individual to make a onetime payment to the "business" and then have that person go out and recruit others to make the same onetime payment. Each time a new recruit makes a payment, the original investor is promised a cut. So in theory, all the recruits will go out and recruit even more individuals and thus lead to a never ending flow of money as the "business" expands. The problem is that money simply flows up the chain and dwindles significantly down towards the bottom. Only the originator of the scam (referred to as the Pharaoh) and some of the top level participants make any real money with the "business (source: wikipedia.org)."

Such businesses are usually spotted by the fact that there is no real product or service that is offered for the money invested. But scammers know this and will come at you with a plethora of fake referrals and testimonials just to make themselves look more legitimate. Still if there is nothing to be gained for your money, a huge red flag should be raised and you should immediately begin to question the legitimacy of the so called business.

Another approach to the pyramid scheme is known as the "8-Ball" model. The 8-Ball model is more sophisticated than that of the most basic model. Some 8-Ball models will claim themselves as a "gifting circle" so as not to arouse any unwanted attention. The basic premise of the 8-Ball model uses 15 people in four tires (1+2+4+8). Each person in the top three tiers is responsible for recruiting two new members. The idea is to have one person on top (the captain), two people below him/her (co-pilots), four people below them (crew) and eight people below them (passengers). The bottom tier or the passengers must each pay a fee (gift) of $1000 for example. That $8000 goes to the captain who then exits the group allowing all remaining members to move up one level. Since there are two co-pilots, the group is split into two and now 16 more recruits must be found to insure those two co-pilots are paid. Then there are four new groups made and the recruiting number goes up to 32 and on and on (source: wikipedia.org).

The problem is that once the scam collapses, the bottom three tiers always lose their money. When the scam collapses it is often after the groups have split multiple times. And many times the originator of the scam will use "shill" or fake names in the first three tiers to insure that he or she is paid the first few times without actually having put in any money themselves. So how do you avoid this type of scam?

If it sounds too easy and too good to be true it's probably because it is. If you suspect a pyramid scheme ask your financial advisor to take a look at any materials that the person recruiting you has to offer. If the person recruiting you seems reluctant, then once again the red flags should be waving. Also be aware of terms used by pyramid schemes that are used to make the "business" sound better. Terms like "original dinner party", "airplane game" and treasure traders" have all been used in the past (source: wikipedia.org). Lastly knowledge is the key. Do your homework and learn more about the concept of pyramid schemes and how the basic models work. The more you know, the less likely you are to fall victim to the scams that are out there.