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A pyramid scheme is a fraudulent business model in which participants earn money primarily by recruiting new members rather than by selling real products or services. Each new participant usually has to pay an entry fee, which is then distributed to earlier members in the structure.
A pyramid scheme depends on continuous recruitment of new participants.
The structure is called a pyramid because early participants sit at the top while new members join at lower levels. Each participant is encouraged to recruit several others, who must also recruit more people to earn money. As the pyramid grows, the number of required new participants increases rapidly. Eventually it becomes impossible to recruit enough new members, causing the scheme to collapse.
Pyramid schemes can often be recognized by the way money is earned. In many cases, participants are encouraged to recruit new members rather than sell real products or services. If most of the promised income comes from bringing in new participants who must also pay an entry fee, structure may be a pyramid scheme.
Short example:
Suppose a person joins a program by paying $500.
The program promises that the participant can earn money by recruiting four new members.
Each of those new members must also pay $500 and recruit four more people. The first participants receive payments from the entry fees of new members. However, as the pyramid expands, it becomes increasingly difficult to find enough new participants. Eventually recruitment slows down and the majority of people at the bottom of the pyramid lose their money.
Disclaimer: Investing brings risks. Our analysts are not financial advisors. Always consult an advisor when making financial decisions. The information and tips provided on this website are based on our analysts' own insights and experiences. Therefore, they are for educational purposes only.
