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Pyramid Schemes: Structures Doomed to Collapse

We've all heard the words pyramid schemes before, but what are they all about? How can some businesses with pyramidal hierarchies be considered legal and thrive? What makes one opportunity a scam and the other acceptable?

There's no doubt that certain business models are considered illegal by FTC. The illegal pyramid is one such model. The illegality of this system stems from the damage it inflicts on its victims. Business models based on the pyramid principle are unsustainable and inevitably doomed to fail.

How Illegal Pyramids Work

This illegal scheme functions solely (or nearly solely) on the recruiting of new members into the scam. An investor is told he or she can make substantial returns on the payment he or she made to enter the scheme by recruiting additional investors.

Once new recruits enter the pyramid, their entry payments (investments) are paid partly to the person who recruited the new investors and partly to the people farther up the pyramid – in other words, the recruiter of the recruiter of the new investors and so on.

Really simply put, money enters from the base of the pyramid and is funneled up the narrowing, pyramidal hierarchy. You can find a more detailed illustration of a pyramid's workings on the pyramid example page.

The fact most worth noting is that the life-blood of the business model is the entry payments of new members or sales to members nearer the model's base, NOT from sales to people outside of the pyramid. This is actually one of the best ways to spot an illegal pyramid.

Why Illegal Pyramds Fail

The answer is geometric growth. Because the entire system is supported by money entering from the bottom of the pyramid, new members must constantly be added to maintain the structure. At some point, the possible number of new recruits is exhausted, and no more people enter the program.

Because the pyramid needed those new recruits to be maintained, it collapses. The simple fact is, there just aren't, and never will be, enough people to maintain a pyramid scheme.

For a more detailed explanation as to why these structures inevitably collapse, check out the pyramid example page.

Why Pyramid Schemes Are Illegal

By looking at the example of an illegal pyramid, it's clear that the majority of investors will lose money, because these schemes are doomed to fail.

In most cases, the operator of the scheme is aware that the model is unsustainable, but recruits new members by fraud – covering up the fact that pyramid must inevitably collapse. The pyramid is misrepresented as feasible means for anyone to make a profit on their investment, regardless of when they enter.

Because scammers can so cleverly disguise illegal pyramids, it makes spotting them all the more important.

These schemes have the potential to hurt thousands of consumers by entering them into a business strategy which has no chance of longterm success. To help keep consumer losses to a minimum these schemes have been made illegal in the US and other countries.

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