Why Are Pyramid Schemes of Investment Unsustainable
Pyramid schemes are doomed to fail because their success depends on the ability to recruit more and more investors. Since there are only a limited number of people in a given community, all pyramid schemes will ultimately collapse. The only people who make money are those few who are on the top of the pyramid. Legitimate multi-level marketing companies, on the other hand, can be around for a long time. Although the recruiting of additional investors is an essential part of the marketing practice, since legitimate multi-level marketing companies involve solid products or services, participants in these companies are not subject to huge losses.
There are many different flavors of financial crime. At a global level the terminology is often imprecise due to different meanings in different legal systems. In this blog series we see “financial crime” as belonging to the broader category of “white collar,” “commercial,” or “economic” crime and explore its linkages to the financial inclusion agenda. We use the term to refer to offences that involve the financial system, payments and transactions. A few recent examples from developing countries and emerging markets: Benin: A number of unlicensed entities that called themselves “microfinance institutions” operated Ponzi schemes. The largest, ICC Services, collapsed in June 2010. By the time the schemes unravelled, they had collected deposits equivalent to about 5 percent of the 2010 GDP of Benin from an estimated 150,000 depositors. According to government data, the average deposit represented 1.5 times the annual GDP per capita.Some assets have been retrieved from the scheme managers and limited restitution is taking place. Colombia: It is broadly estimated that as many as 4 million Colombians invested over US$1 billion in pyramid schemes in the mid-2000s. In 2008, the collapse of one scheme (DRFE) led to rioting and violent protests in 13 cities. The government declared a state of emergency to restore order.
A Ponzi scheme is a type of fraudulent investment strategy. Typically fraudsters promise very high returns, and use money from new recruits to the scheme to pay off early-stage investors, until the scheme gets so big that the inflow of new money is insufficient; at which point the scheme collapses amid losses and recriminations (Sander, 2009, p.2). The fraud is often assisted by intermediaries who are reckless and negligent, rather than dishonest, and who guide investors towards the scheme. The beneficiaries are either well-informed and dishonest (the scheme promoters), wilfully and negligently ill-informed (intermediaries), or ill-informed but fortunate (investors who withdraw their funds before the collapse). The victims, those left with worthless investments, are both ill-informed and unlucky.
Pyramid schemes are illegal in many countries. The model of profiting by using the network effect often traps individuals into recruiting their acquaintances, which can feel slimy for everyone involved and can ultimately strain relationships. Investors should exercise caution with such schemes or simply avoid them altogether.
Sander, P. (2009). Madoff: Corruption, Deceit and the making of the World's Most NotoriousPonzi Scheme. OM Books International, Noida.