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What is Pyramid Scheme and How it works?

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Many businesses have found success with so-called “multi-level marketing” approaches in recent years. It’s crucial to understand the distinctions between a pyramid scheme and a legitimate multi-level marketing firm.

To begin, it is important to remember that pyramid schemes often fail, while multi-level marketing companies sometimes succeed.

What is Pyramid Scheme?

A pyramid scheme is an unsustainable business model in which the original investors profit from the recruitment of new investors rather than from the sale of goods or services.

The model works by requiring new investors to make a one-time deposit before being able to participate in the scheme.

The funds raised by new hires are used to repay the initial investors. After that, potential participants are given money if they can attract more people into the system.

The scheme is referred to as a “pyramid” because the number of investors increases with each stage. The small group of top promoters needs a wide base of later investors to fund the scheme by paying out dividends to the early investors.

In New York State, as well as several other states, pyramid schemes are illegal. Initiating and engaging in pyramid schemes is illegal under Article 23A of the General Business Law of the State of New York (also known as chain distributor schemes).

Items or distributorships may or may not be sold in pyramid schemes. In an effort to demonstrate credibility, the trend is to include product sales or distributorships.

This is done solely to avoid regulatory authorities, since most state regulations ban marketing activities in which the primary source of profit is the recruitment of new buyers rather than the selling of goods.

The bottom line is that the sale of a commodity is much less important in all pyramid schemes than the recruitment of new investors.

How pyramid scheme works?

The scheme is designed in the shape of a pyramid, as its name implies. It all begins with one person at the top of the chain of command: the initial recruiter. The person hires one other person who must spend a certain amount of money.

After that, the upfront payment is made to the original recruiter. To recoup his investment, the new recruit must recruit more members under him, each of whom will make an initial investment.

If the recruit can convince ten or more people to join, he would have made a significant profit on a small investment.

Each of the newly recruited members is responsible for recruiting additional members. A person receives a significant profit for every ten people he or she hires, minus the initial payment made to the person who recruited him.

The scheme’s recruiting is continuing to the point that it can no longer maintain itself. Those at the top of the pyramid have made big profits at this stage, while those at the bottom have lost their money.

The problem is that such a scheme would not last very long. There is a limit on how many people will enter. Members are duped into believing that saving would result in a large benefit.

In fact, the scheme has rarely resulted in the development of capital, nor has it resulted in the acquisition of assets by the scheme’s organizers.

Types of pyramid schemes

1. Multi-Level Marketing (MLM):

Multi-level marketing (MLM) is a legal business activity, although it differs from conventional pyramid schemes in that it includes the selling of real products or services.

Participants, on the other hand, are not forced to close any transactions in order to raise money by hiring members below them.

Since they sell printed materials with no real meaning, such as educational courses, some MLMs are almost indistinguishable from pyramid schemes.

These MLM schemes succeed by pressuring recruits to purchase low-value goods at exorbitant prices and then forcing them to sell the same products to the next generation of members.

2. Email Chains:

Chain emails encourage unsuspecting users to contribute small sums of money to someone on the email’s list.

After making the donations, the donor is asked to replace the first name on the list with his own, then forward the chain to his own network of contacts in the hopes that one or more of them will give him money.

Theoretically, beneficiaries continue to receive donations until their names are removed from the list.

3. Ponzi Schemes:

Ponzi schemes are investment schemes based on the concept of “robbing Peter to pay Paul.” They do not have the hierarchical structure of a pyramid scheme, but they do offer high returns to current investors by taking money from new investors.

Most Ponzi investors lose everything after being enticed by the promise of too-good-to-be-true returns.

Why Do Pyramid Schemes Fail Every Time? Why Do Legitimate Multi-Level Companies Survive on Occasion?

Pyramid schemes are doomed to fail because they depend on the ability to attract more and more investors to succeed.

All pyramid schemes would inevitably fail due to the small number of people in a given group. The few who are at the top of the pyramid are the only ones who make money.

On the other hand, legal multi-level marketing companies will last a long time.

While attracting additional investors is a vital part of marketing, legitimate multi-level marketing companies use solid goods or services, so participants are not at risk of losing a lot of money.

Conclusion

In certain countries, pyramid schemes are banned. The network effect benefit model often traps people into hiring their mates, which can feel slimy for anyone involved and eventually strain relationships.

Investing in such schemes should be done with caution or avoided entirely.

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