Pyramid scheme

Lou Pearlman, convicted of running one of the longest-running Ponzi schemes in history.

I, the crown prince of Nigeria, offer you Scams

Hook, line, and sinker

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Totally sounds legit!

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Were you looking for the Egyptian Pyramids?

“”Frank Reynolds: It's a pyramid scheme! Dee Reynolds: It's not a pyramid scheme! It's a reverse funnel system! Frank: Turn it upside down. Dee: Oh, shit! Frank: All right, you've been duped, suckers.

—It's Always Sunny in Philadelphia

A pyramid scheme is a common scam, also known as an endless chain because it recruits members in, well, an endless chain. Suckers pay in, on the promise they'll be paid a cut of the return from their recruits, their recruits' recruits, and so on. Membership grows exponentially (hence the pyramid shape), and recruiting quickly becomes impossible; when the scheme collapses as a result, those at the top of the pyramid have siphoned all the money from everyone else at the bottom.

The endless chain scam is at least a century old, but the Internet is what's really ushered in its golden age. That's because it spreads virally, which is why it can be considered a form of affinity fraud. The most basic pyramid schemes are naked get-rich-quick scams which don't even pretend to offer any service or product; these are illegal in most countries. Some pyramid schemes add product sales to skirt those laws, and operate (quasi-)legally.

Do the math

A pyramid scheme, like this "airplane game", can be represented as a binary tree with a branching factor of 2.

The classic pyramid scheme is sometimes known as the eight-ball model, and it still pops up frequently under the names "birthday party", "gifting circle", "cash club", and "airplane game", among others. In an eight-ball scam, seven scammers form the first three layers and solicit a sum of money from eight suckers, which is paid to the scammer at the top of the pyramid. The top of the pyramid leaves, the pyramid divides in two, and the cycle repeats with each scammer/sucker advanced one level up the pyramid.

It doesn't take a Ph.D. in mathematics to see that the bottom 3 levels of the pyramid always lose money. At just ten levels deep, that's 894 people — a loss rate of more than 87%. With just one additional recruit per level, that loss rate climbs to more than 96%, and with more than three recruits, loss rates are practically indistinguishable from 100%. You also don't have to be a math genius to see that even with just two recruits per level, the simplest possible pyramid scheme, after not even 30 iterations the number of total suckers exceeds the population of Earth. And that's assuming that every man, woman, and child on the planet wants to sign up — the scheme obviously runs out of people willing to join well before that.

In cocaine-fueled well-paid social circles, this game is played for "fun" – as long as a group keeps playing, the money just changes hands between them. The "excitement" comes partly from the ever-present risk that one will lose a couple thousand dollars if people stop playing.

Related scams

The endless chain's enduring popularity is partly due to its adaptability.

Ponzi schemes

The man who made it famous, Charles Ponzi

Pyramid schemes are similar to Ponzi schemes, so much that the two phrases are used interchangeably. In both schemes, early investors are paid using the investments of later investors. The main difference between a pyramid scheme and a Ponzi scheme is that in a pyramid scheme, money passes from one level to another, while in a Ponzi scheme, all of the money goes through the scammer. While early investors in a Ponzi scheme will profit at the expense of later joiners (assuming they aren't, as often happens, suckered into rolling their money into further "investments"), they aren't directly taking money from the later joiners.

In a pyramid scheme, however, early joiners act as both victims and perpetrators. Since Ponzi schemes have an intermediary between participants, their nature tends to be less transparent. With a pyramid scheme, participants often don't bother questioning where the money is ultimately coming from, but it is clear to anyone who bothers to seriously examine the system that there is no source of funds external to the participants. The scammer in a Ponzi scheme, on the other hand, usually presents some purported external source of money, typically some complicated financial strategy. Depending on the scheme, the explanation can vary wildly in both specificity and plausibility, although it is almost always sufficiently lacking in both that it does not stand up to careful examination.

Another difference is that, since a Ponzi scheme necessarily involves an operator to act as an intermediary, that scammer is there the entire time the scheme is running and therefore the original perpetrator is usually held accountable, whereas a classical pyramid scheme's original perpetrator can easily slip away once they "pilot out".

Matrix schemes

Matrix sales, also known as ladder schemes, are websites where suckers purchase an item, typically of little value, in order to be added to a waitlist for a product of much higher value. To win the prize, an endless chain of new purchasers must sign up, and most people who sign up (>90%) lose. Matrix schemes are an attempt to skirt laws prohibiting franchise fraud by ostensibly offering a product for sale. This scam emerged in the early 2000s and was very popular in the UK before it was banned in 2005. Matrix schemes are also in legal limbo in the US and payment processors have mostly blocked them.

Multilevel marketing

See the main article on this topic: Multilevel marketing

Like matrix schemes, Multilevel marketing (MLM) companies, of which Amway, Shaklee, Herbalife, and Young Living are among the best known, are legally distinguished from illegal pyramid schemes because they sell products, and income is (supposedly) derived primarily from sales of those products to outside parties. However, for most, income derived from selling products is dwarfed by income derived from recruiting new members who are obliged to buy stock or franchise rights or make some initial investment, making the distinction slight in a practical sense (but not in the legal sense).

Some pyramid schemes will try to pass themselves off as multilevel marketing, with the "product" being sold mainly consisting of information, or mainly sold only to new people recruited into the business. In practice, the legal distinction between the two is often a fuzzy one. For these reasons, many people charge that MLMs are nothing more than legalized pyramid schemes.

Religious aspects

Because pyramid schemes rely on social contacts, religious affiliations can be a particularly useful structure for creating the pyramid. Religious people already have faith in a religion, so why not exploit it for faith in the scheme? John 1:35-46 has been called the original pyramid scheme by one Christian leader (although this comparison is admittedly tenuous, as the passage in question does not involve any actual money or products changing hands, merely the recruitment of converts, which pretty much every religion except Zoroastrianism and the religion of the Yazidi engages in). In Papua New Guinea, the most notorious pyramid scheme, known as "U-Vistract", was organized as a form of Christian mission. Religious pyramid schemes are not restricted to Christians. In 2010, an Islamic, "sharia compliant" ponzi scheme was broken up for defrauding investors of US$43 million. Another pyramid scheme targeted Orthodox Jews in the US. Buddhists have also been targeted in ponzi schemes.

Put on the pyramid-shaped tinfoil hat

Pyramid scheme promoters frequently also promote pseudolaw, pseudoscience, and quack health nostrums. Pyramid schemes have existed involving the sale of everything from pseudo-legal training in debt elimination and "sovereign citizenship" scams, to non-working devices purported to run your car on water, to ineffective improve-your-eyesight exercises.

Objections and counterarguments

"Pyramid schemes are illegal, and this opportunity doesn't meet the legal definition of a pyramid scheme."

Yeah, well, that "herbal smoking blend" for sale at the gas station doesn't meet the legal definition of a drug. National laws change, mathematical laws don't. If it's mathematically indistinguishable from a pyramid scheme, it's a sure way to lose money, whatever the law says, and any investor with two nerve cells rubbing dicks knows that.

"Pyramid schemes lie and deceive people. This opportunity is transparent because nobody is guaranteed/promised a profit."

Show me a single pyramid scheme that guarantees a profit. Show me one. You can't, because the transparent criminality of such a scheme would ensure its immediate discovery and shutdown by law enforcement. A pyramid scheme doesn't need to guarantee profit — all it needs to create is the tantalizing expectation of profit, in enough people to create a small buzz. The few who choose to cash out become the scheme's main promoters.

"By that definition, the stock market/corporate ladder/Social Security/reserve banking/fiat currency is also a pyramid scheme."

See the main articles on this topic: Social Security, Fractional-reserve banking, and Fiat currency

(I'll take a double Ipecac on the rocks with extra Tramadol, please.)

It's common to see sleazeball pyramid builders prey on the financial insecurities of the vulnerable by trotting out this dreadfully tired and oft-refuted cliché: that any hierarchy with a superficially triangular structure meets the definition of a pyramid scheme. It doesn't help that many pushers of doomsday scenario paranoia and rugged individualism denigrate systems designed to operate with little or no assets on hand as pyramid schemes.

Comparisons like this all ignore the fundamental, defining, and characteristic feature of pyramid schemes: that they never create value or capture it from the market at large — it only comes from endless new participants in the scheme:

• The stock market isn't a pyramid scheme because stocks represent company profits, dividends, cash buybacks, etc. from selling products/services to customers — not new investors!
• A nine-to-five job isn't a pyramid scheme because it's a position with pay/benefits. An employer covers this with profits from selling products/services to customers — again, it doesn't just fly outta new investors' pockets!
• Precious metals (silver/gold and others) are a special case, but still not a pyramid, because of their unique ethnocultural history and importance in high-value industries like jewelry and electronics.
• Fiat currency isn't a pyramid scheme because of inflation: nobody "invests" in cash with the expectation of profit because it'll lose value. (A little inflation's a good thing, remember — hoarding cash means less spending.)
• Fractional-reserve banking isn't a pyramid scheme because it doesn't rely on an endless chain of new deposits to survive. A bank can’t expand its business without new deposits, but it doesn’t collapse.
• Social Security isn't a pyramid scheme because it is sustainable in perpetuity... or at least it could be if the government did something unpopular but essential: adjusting the age raising the payroll tax cap.

"People enjoy participating and do so willingly — what's the harm?"

Bullshit. Ponzis, pyramids, and related schemes are promoted in a strikingly uniform manner with an unmistakable emphasis on money, not "entertainment". Those in financial trouble or without English skills, often targeted by fraudsters, cannot be described as "willing" by anyone with a functional soul. And many people who do knowingly invest in Ponzi schemes are intending to profit at the expense of later investors by "get[ting] in on the ground floor" with cryptocurrency. Pyramid schemes grow to hundreds of thousands of real victims who lose millions, and losses are often compounded by borrowing from credit cards or against collateral. In Albania, pyramid schemes nearly caused a civil war.

Cryptocurrency

Several months prior to the collapse of the FTX cryptocurrency and partner company Alameda Research, Sam Bankman-Fried (SBF), the CEO of FTX had came very close to publicly admitting that it was all a Ponzi scheme. Journalist Matt Levine asked SBF about the common cryptocurrency practice of yield farming:

SBF: You start you start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing you know, world-altering protocol that's going to replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box so what this protocol is it's called protocol X. It's a box that you can take a token. You take Ethereum, you can put it in the box and you can take it out of the box like you put it into the box and you get like you know an IOU for for having put it in the box and then you can redeem that IOU back out for the token. So far what we've described is the world's dumbest ETF or ADR or something like that. It doesn't do anything but let you put things in it if you so chose and then this protocol issues a token we'll call it whatever X token and X token promises that anything cool that happens because of this box is gonna ultimately be usable by you know governance vote of holders of the X tokens. They can vote on what to do with any proceeds or other cool things that happen from this box. And of course so far we haven't exactly given a compelling reason for why there ever would be any proceeds from this box but I don't know. You know, maybe there will be, so that's sort of where you start and then you say alright, well you got this box and you got X token and the the box protocol declares or maybe votes by [incoherent word]-governance or you know something like that that what they're going to do is they are going to take half of all the x tokens that will have reminted maybe two-thirds though two-thirds of all offer X tokens. And they're going to give them away for free to everyone who uses the box so anyone who goes takes some money puts in the box each day. They're gonna airdrop you know one percent of the X tokens pro rata amongst everyone who's put money in the box. That's for now what X token does it gets given away to the box people and now what happens well X token has some market cap right, it's probably not zero well let's say it's you know 20 million dollar market cap and a bunch of arbitration.

Levine: From like first principles it should be zero.

SBF: Uh sure okay I completely reasonable comment

Levine: like I mean like that's not quite true but it's like when you describe it in this totally cynical way it sounds like it should be here but go on.

SBF: Describe it this way you might think for instance that in like five minutes with an internet connection you could create such a box in such a token and that it should reflect like you know it should be worth like 180 or something market cap. For like that you know that effort that you put into it in the world that we're if you do this everyone's gonna be like ooooh box token. Maybe it's cool if you buy a box token you know that's going to appear on Twitter and I'll have a 20 million dollar market cap and of course one thing that you could do is you could like make the float very low and whatever. … And so then you know X token price goes way up and now it's at 130 million dollar market cap token because of you know the bullishness of people's usage of the box and now all of a sudden of course the smart money's like oh wow like this thing's now yielding like 60 percent of your next tokens. Of course i'll take my 60 yield right so they go they pour another 300 million dollars in the box and you get a cycle and then it goes to infinity and then everyone makes money.

Levine: I think of myself as like a fairly cynical person and that was so much more cynical. I would have described farming like you're just like well I'm in the Ponzi business and it's pretty good.

SBF: Let me play around with this a little bit right because that that's one framing of this, and I think there's like a sort of depressing amount of validity.

…

Two months after this April 2022 interview and after bailing out some crypto funds, SBF warned that "There are some third-tier exchanges that are already secretly insolvent." By November FTX and Alameda Research themselves collapsed and were in bankruptcy.

See also

• Bernie Madoff
• Multilevel marketing
• Pump and dump
• Vemma

External links

• Multilevel Marketing: Last Week Tonight with John Oliver
• See the Wikipedia article on List of Ponzi schemes.