A:

Pyramid schemes and Ponzi schemes share many similar characteristics in which unsuspecting individuals are fooled by unscrupulous investors who promise extraordinary returns. However, in contrast to a regular investment, these types of schemes can offer consistent "profits" only as long as the number of investors continues to increase. Ponzi and pyramid schemes are self sustaining as long as cash outflows can be matched by monetary inflows. The basic difference arises in the type of products that schemers offer their clients and the structure of the two ploys.
Ponzi schemes are based on fraudulent investment management services – basically investors contribute money to the "portfolio manager" who promises them a high return, and then when those investors want their money back they are paid out with the incoming funds contributed by later investors. The person organizing this type of fraud is in charge of controlling the entire operation; they merely transfer funds from one client to another and forgo any real investment activities.

On the other hand, a pyramid scheme is structured so that the initial schemer must recruit other investors who will continue to recruit other investors and those investors will then continue to recruit additional investors and so on. Sometimes there will be an incentive that is presented as an investment opportunity, such as the right to sell a particular product. Each investor pays the person who recruited them for the chance to sell this item. The recipient must share the proceeds with those at the higher levels of the pyramid structure.

There are two additional important factors to consider: the only guilty party in the Ponzi and pyramid scheme is the originator of the corrupt business practice, not the participants (as long as they are unaware of the illegal business practices). Secondly, a pyramid scheme differs from a multi-level marketing campaign which offers legitimate products.

For related reading, take a look at What Is A Pyramid Scheme? and The Ghouls And Monsters On Wall Street.

This question was answered by Arthur Pinkasovitch.

RELATED FAQS

  1. What are the major laws (acts) regulating financial institutions that were created ...

    Read about the major federal responses to the financial crisis of 2008, such as the Dodd-Frank Wall Street Reform Act and ...
  2. What are the similarities and differences between the savings and loan (S&L) crisis ...

    Learn about some of the similarities and differences between the savings and loan crisis and the subprime mortgage crisis ...
  3. What measures could the U.S. Government take to prevent another crisis similar to ...

    Discover what measures the U.S. government could take to prevent another crisis similar to the S&L crisis. The S&L crisis ...
  4. How was the American Dream impacted by the housing market collapse in 2008?

    Learn how the American Dream was impacted by the housing collapse in 2008. Due to the housing collapse, millions ended up ...
RELATED TERMS
  1. Regional Asset Liquidation Agreement (RALA)

    An agreement between an asset manager and the Federal Deposit ...
  2. The New Deal

    A series of domestic programs designed to help the United States ...
  3. Accelerated Resolution Program (ARP)

    A program designed to reduce the time and cost of resolving failed ...
  4. Asset Liquidation Agreement (ALA)

    A contract between the Federal Deposit Insurance Corporation ...
  5. Capital Loss Coverage Ratio

    The difference between an asset’s book value and the amount received ...
  6. Gross Cash Recovery (GCR)

    The gross cash colloctions expected over the remaining life of ...

You May Also Like

Related Articles
  1. Stock Analysis

    A New Economic Threat: State-Sponsored ...

  2. Credit & Loans

    Which Is One Of The Nation’s Safest ...

  3. Economics

    The New Global Banking Regulations To ...

  4. Investing News

    Will Bitcoin And Walmart Force Western ...

  5. Active Trading

    What Is A Pyramid Scheme?

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!