Types of Pyramid Schemes: An Advice to Financial Institutions

            Types of pyramid schemes

This paper reviews the nature of different pyramid schemes to raise consciousness among financial institutions and non-financial institutions. The paper also analyses the possible adverse outcomes of the various types. With the current advancement in communications and information technologies, pyramid schemes have been on the rise as people try to bring in vast multitudes of the population. With an increase in global economic competition, businesses and individuals have realized the need for pyramid schemes to keep up with the harsh economic times. As the name suggests, pyramid schemes comprise a stratified structure where many people are recruited into the systems in an expectation that they help generate returns from the programs (Bosley & Knorr, 2018).

In these pyramid schemes, investors at the lead are paid through the entrance fees paid by newly inducted investors. Investors must maintain a geometrical amelioration, which ensures that the number of inducted members equals that of the existing members so that funds can be proportionately distributed to keep the pyramids in function. Initially, members are motivated through consistent and high incomes. Good income for the members acts as a good advertisement for the pyramid. Over time, the pyramid schemes flourish to a certain level, where it is almost impractical to get recruits. At this stage, the short period is over. Investors at the top of the pyramid or its first inventors usually have already benefited from super-profits made from those at the bottom (Akinladejo, Clarke & Akinladejo, 2013). On the other hand, participants at lower levels experience losses and are not subjected to any profits considering the scheme’s threatening and imminent downfall

.           The majority of these pyramid schemes operate as perfectly as promised during the early stages and for those at the higher levels. Early investors, who are the advertisers of the systems, must maintain and portray the schemes’ attractiveness to the public. This eventually misleads the people, who, in turn, invest in the pyramids but at different policies as those of the early investors. For example, the entrance membership fees are usually increased with time. In most of these pyramids, recruits are expected to recruit more people than the early investors did to gain returns.

The creation of these unrealistic returns schemes has forced many governments to illegalize their operations. While the organizers are aware of the scheme’s outcome, members of the public are entirely unaware and diving in with the hope of creating fast returns. In conclusion, pyramids schemes are scams and are often conducted in disguised ways. This section of the paper discusses the different ways in which the various pyramid schemes are managed.

The following are the most common types of pyramid schemes:

The eight-ball model

The eight-ball model is also known as the airplane game (Corden, 2018). The model is a non-sustainable type of pyramid scheme that is formed with only a definite number of players. With a limited number of players, this model is the simplest of all models, unlike others that are complex and complicated. The scheme includes the exchange of money with the people that one enroll in the pyramid. This model exists in a financial or non-financial institution to create value to the institution either socially or economically. It is established to portray some tactful business aspects, such as establishing infrastructure, trading routines, and other practices. However, it is important to note that there are no tangible products or services exchanged, making the model illegal in most countries.

The hierarchical system has four tiers. The four tires are referred to as the captain, co-pilots, the crew, and the passengers, respectively, from the top. These terms are used to refer to a participant’s level. In total, the model has 15 participants. Each participant in this scheme should only recruit a maximum of two people. The captain level has one person who recruits two other members into the pyramid. These two people then form the co-pilot’s tier. Consequently, the two co-pilots each recruit their two people into the pyramid resulting in the third tier with four members. Thereon, the four members each enroll two other people forming the fourth tier with 8 participants.

For a player to join in the pyramid scheme, they have to pay at least some amount. For example, if the entrance fee is $100, a total of $800 is collected from the passengers. This amount is given to the captain who evacuates from the scheme. Next in, the group splits into two, with each co-pilot becoming the captain in the new groups and recruits their passengers. When the captain withdraws from the pyramid scheme, the other remaining members move a level up higher in the pyramid. This cycle continues down to the eight passengers. Usually, members at the passenger’s level do not receive any amount until they have advanced through all the tiers, the crew, the co-pilot, and the captain.

The pyramid is risky because if the pyramid scheme collapses, only the captain benefits from it. The passengers who paid to enter the system will lose their money as they will not benefit since they cannot recruit more people in the case of a collapse (Khalili, Ismail & Karim, 2017). More so, the eight-ball model has been used to scam people. The captain uses fake names to take up the positions of the co-pilots. They act on behalf of the members using counterfeit names and benefit from the payouts without paying the passengers’ entrance fee. They are, therefore, able to benefit significantly before the scheme collapses.

Multi-Level marketing

Multi-level marketing is also referred to as the network marketing model. It is a business model that companies apply to market their products through their customers (Antler, 2018). Customers act as marketing agents and get to benefit from recruiting other customers to the company. This model operates on a commission-based strategy. This model is different from the eight-ball model in that it involves selling products or services to make money, unlike the eight-ball model that makes money just by recruiting members to a scheme. This scheme is being adopted by many companies in today’s business world, especially since it’s convenient even in a virtual environment; thus, there are no geographical limitations.

There are three types of multi-level marketing (Girish & Dipa, 2015), which include single-tier, two-tier, and multi-level.

Therefore, the buyer/ customer becomes a distributing agent responsible for recruiting other buyers to become distributor agents. The advertised products are used as a diplomatic strategy to trick people into the pyramid scheme. As mentioned in the eight-ball model, where the passengers pay for an entrance fee into the system, multi-level marketing uses the payment of products method to recruit a person into the scheme. Usually, these products are of low price or even no financial worth products that are overcharged. The buyer is expected to explain specific characteristics of the products being sold to reveal its presumed value and vindicate the overpriced products for them to appear more trustworthy. The overcharged prices replace the intended entrance fee. This tricks the buyer to thinking of the pyramid as an investment, which encourages them to go further into the scheme.

Compared to other pyramid schemes, the network marketing model appears to be legit. In that, the company involved can circumvent illegal economic activities associated with pyramid schemes. It misleads people to perceive the company as one involved in the trading of goods (Rezvani, Ghahramani & Haddadi, 2017). The overpriced products deceive people into believing that they sell high-quality goods, creating a credible and honored image.

However, some of these market networks are legal and trustworthy and are different from pyramid schemes. It is essential to differentiate this type of marketing from other pyramid schemes that are started by fraudsters. Network marketing products are sold at the average market price to profit from regular buyers, while pyramid schemes products are sold at significantly higher prices for value goods by crediting the assets with non-existent features and functions. More so, products in legit network marketing are usually available for sale to the public, while products in pyramid schemes are not available for sale to the public. Further, pyramid schemes require the recruitment of new members despite selling the products while members from a network marketing scheme gain their commission just from selling their products without recruitment (Keep & Vander, 2014). Lastly, pyramid schemes are known to sell large quantities of goods at once, which normally should not be sold out altogether at once within a short period.

Matrix schemes

The matrix scheme is an unsustainable type of pyramid scheme business model. To enter into such a system, a person pays a certain amount of money, and their names are then queued on a waiting list (Bassan, 2018). Ideally, the name at the lead of the list receives the coveted outcome under a condition that a precise number of people join this list. The last person to join is added at the bottom of the list, and their name goes up the list as more members get recruited. Every new member creates another level increasing the pyramid scheme vertically. The coveted outcome is mostly a highly-priced commodity such as electronics, trips, or even cars.

This type of scheme is very risky; the reason is that it requires a lot of money to join the waiting list queue, and most people do not get to the top level. As the scheme expands, getting enough people to join the system for it to keep going is gets harder. This eventually leads to collapse, and everyone else not at the top of the list ends up losing all the money they had paid initially(Jack & Ibekwe, 2018). Worse still, the amount paid by a person to get to the system is often overpriced. People buy products such as cell phones, e-books, or software compact discs at a higher price than the average market price of the good. In such a case where the money is not lost, people end up not benefiting from anything apart from that first overpriced product they bought initially.

This scheme operates on a confidence trick by the operators, which can be referred to as gambling. An excellent example of this matrix scheme is phones4Everyone. In this scheme, people joined the waiting list by paying $35 for a signal rooter of a specific cell phone. The coveted prize to be won was laptops and iPods. About 18000 members paid for the signal rooter. Unfortunately, only a few of them received the promised iPod and laptops. Detractors state that, even with the addition of more people into the scheme, the bigger percentage of the participants do not receive this award at the end of it all.

The matrix is a fraud since the scheme’s organizer remains as the larger gainer without any investments. They benefit from pay-ins made by people entering the systems, usually more than the payouts made to those at the top of the list (Obamuyi et al., 2018). Additionally, the effort needed by the individual at the top in recruiting other members is different from the people following in the list. For example, if the first person on the list requires ten people, the second person requires 20 more people— ten people for the first person and ten more people for themselves. Consequently, the third person needs 30 more people to join in. Ten for the first person, 10 for the second person, and 10 for themselves. This means that the number of additional signs up continues to grow as the list increases vertically, making the process more cumbersome for those at the bottom of the list who initially were not informed about this perspective of the matrix pyramid scheme.

Ponzi schemes

Ponzi schemes are another counterfeit type of pyramid scheme. It starts with the old investors investing heavily in the schemes to attract and lure other investors into devoting more money. Early investors are then paid with funds paid by the new investors (Lee, Lau & Loi, 2016). Such schemes were named after fraudster Charles Ponzi who came up with the idea of aggregating large profits within several months of operation. Later on, the big scam would collapse and lead to the imprisonment of Charles.

The scheme offers fake promises to the new investors, such as a 50 percent return profit with no potential risks involved.

There is no justifiable investment venture into these schemes. Instead, they focus on achieving the promised profits through money cashed out by new investors. The system stays in function by circulating the subsequent investors’ funds, which requires a consistent and stable stream of funds (Chen et al., 2018). The raised amounts are distributed to the old investors, and others retained for the organizers who lead a lavish lifestyle. Such lavish lifestyles make the scheme look real and eventually lure potential investors into the system. This scheme is, however, deemed to collapse when there are no more members to be recruited.

Ponzi deceives and tricks investors into believing that they are entering an investment plan and will earn their profits through this plan. What they are not aware of is that they make profits by bringing more people into the scheme. Investors should be wary of such projects by observing some common red flags such as the assurance of high-profit returns at low risks (Carey & Webb, 2017). In the business world, high-risk businesses typically make higher returns than low-risk companies. Therefore, a controversial type of investment should be framed as a too good to be true deal, and one needs to evaluate such an investment before getting into it critically.

Another cause for doubt over the Ponzi scheme is the overly constant and dependable returns. A typical business investment encounters up and down challenges over time. However, Ponzi schemes generate productive outcomes regardless of the market’s states. More so, such schemes are not usually registered under anybody. Further, you can easily identify such fraud investments through their complicated paying methods. Ponzi schemes encourage investors not to withdraw full amounts at a time. Instead, they offer higher returns for people who do not cash out all funds. This tricks the members into preventing them from making massive cashouts. Such schemes are always complex to explain. They do not offer enough knowledge to the investors.

In conclusion, Ponzi schemes can be thought out as pyramid schemes despite that the participants are not conscious of this pyramid nature. However, it is different from pyramid schemes in the ways such as; funds are passed indirectly through a non-hierarchical system and unlike other pyramid schemes where the investors convince and recruit new members, in the Ponzi scheme, the trickster, who is the scheme’s organizer, is the one devoted to the enrollment of new members.

Compare the differences in pyramid schemes in different countries China and Albania.

The concept of pyramid schemes as investment scams schemes varies all around the world. Some countries perceive these schemes as top spots of financial institutions where individuals can earn, for example, the United States (Keep & Vander 2014). However, other countries such as Germany, China, and Albania view the schemes as fraud schemes (Modic & Anderson, 2015). Particular concerns pertain to the rapidly evolving financial systems met by the high level of illiteracy among the population within the realm of an investment possibility.

These financial systems lack efficient laws and regulations that govern how pyramid schemes are operated. Countries are adapting to the fact that that losses or bankruptcy resulting from these schemes after they collapse are not redeemable and cannot be recovered. That does not mean that these countries have not heard of disgorgement of illegally obtained profits, but the process may be just tiresome and is likely to bear no fruits. This section aims to compare China and Albania countries’ comparative law by discussing selected pyramid schemes from the two different countries.

Pyramid schemes in Albania

Albania is among the developing countries in Europe. The country encountered a pyramid scheme crisis between 1996 and 1997 (Thanasi & Riotto, 2017). For many years, the country had remained inaccessible due to its low and poor economic state. The Albanian pyramid scheme lured at least two-third of the country’s population to get to the systems by promising sure and substantial profit returns. The Albanian pyramid schemes began in 1991 when the country had been wholly stricken by poverty and desperation. Initially, like all other pyramid schemes, the country’s gross domestic product rose to at least ten percent.

Lack of a well-established financial system was among the major causes of Albania’s pyramid schemes. The financial system was inefficient and unreliable. Due to the poor economic state, the private banks grew at a languid pace. The poor system led to the upsurge of an informal financial system.  The Albanian jurisdiction abided by the informal market transition, which was thriving as compared to the existing formal market.

Informal markets constituted colloquial lending firms that later became pyramid schemes. The majority of these firms were formed between 1991 and 1992. Until 1995, the firms offered loans to members at 4 percent to 5 percent interest rates monthly (Nexhipi & Nexhipi, 2017). The companies were involved in great investment strategies and some even financed illegal activities such as drugs and arms trafficking. While it was hard to distinguish between the informal firms and the pyramid schemes, both companies were operating without licenses and were beneficial opportunities for small businesses in the country.

Due to the Albanian government’s inadequate enforcement measures, these companies did not undergo any auditing to verify their transparency. However, in 1996, the Albanian banking system passed a law that states that companies were nor eligible to accept any deposits from the citizens. The central bank made a notice to the informal companies informing them to take business licenses to legalize their companies. However, government members were already participating in these pyramid schemes and hence were reluctant to follow the directives given by the central bank. The companies supported the politicians in the 1996 election campaigns, which clearly showed that the government was directly benefiting from these schemes (Feng, Sun & Gong, 2019). The schemes supported the election through paying for advertisement posters and organized political parties. This reliable support from these pyramid scheme companies to the government led to the negligence of the banks of Albania, whose governor was left alone in persuading for the investigation and the termination of these pyramid schemes.

In 1996, more pyramid schemes began to rise, bringing in more depositors, which urged the companies to raise their interest rates. At the time, the largest companies offered a 4 to 5 percent rate, and by the first half of the year, the companies raised their interest rates from 6 to 10 percent. Other new schemes sprang up within the year and had their interest rates at 12 to 19 percent. All of these companies have no authentic investments apart from being just deposit companies. With the increase in the percentage rates, more depositors were attracted to the pyramid schemes. By September, the companies were already offering interest rates that were over 30 percent per month. By the end of the year in November, pyramid schemes such as Xhafferi and Sude offered extended the interest rates to above 40 percent per month. By this time, the companies’ liabilities had hit approximately $1.2 billion. This massive number did not stop the mania that enthralled the country at this moment.

More depositors continued to pour in to deposit their funds. The pyramid scheme’s queues became longer with all classes from the poor to the rich. Some People believed that the programs had full government support, while others thought that the pyramid schemes gained their funds from illegal activities. With this belief in mind, they were sure that the illicit activities and the government would ensure security for their returns. People sold their livestock and land to devote their money in the schemes.

The world bank warned the public of the possible risks associated with these pyramid schemes, which all fell on deaf ears. The world bank had consistently given strict warnings from 1994 until 1996 when it gave a stringent warning (Zhukri, 2015). Together with the IMF, the bank accused the Albanians of contesting against the country’s most fortunate companies. All this came to a fall when the Sude pyramid scheme company failed to make its payments, and the downfall began. After four months, the other pyramids also defaulted to make the promised payments leading to a collapse of the whole system. The pyramid scheme collapse brought down the ruling country’s ruling party (Jarvis, 2000), leaving the country lawlessness and death of at least 2000 people due to violence after the collapse of the pyramid schemes.

Pyramid schemes in China

China has not reported too many cases so far. However, several fraud cases have been published by international media as of 2007. The manufacture of items in china has contributed to the growth in Pyramid schemes. For example, cheap knives and other cheap supplement products are among products that are sold at cheaper prices to convince  investors to enter into a pyramid system .This paper focuses on two pyramid schemes: the ant sales scheme and the Ezubao and their exposure to the economic market. In 2014, a p2p lending company known as Ezubao was created to offer financial help to businesses and individuals (Albrecht, Morales, Baldwin & Scott, 2017). Initially, investors were more than willing to invest their money in the scheme in the expectation that the money would be refunded with some interest rates from the money repaid by the borrowers. More so, this scheme promised to deposit at least seven times the interest earned directly into their banks and at least 15 percent annual returns.

The pyramid scheme advertised its advertisement through China’s central television, which built more trust from potential investors. The project was marketed and promoted through sales agencies from all over the country, and thousands of individuals and businesses joined with high expectancy. Approximately 900000 investors invested in this scheme, and the company had liabilities of about $7.6 billion. The majority of the scheme’s investors were the poor group from the rural areas. Apart from its advertisement on national TV, its contribution to the 12th association between southeast Asia and china nations expo gained more trust for the pyramid scheme. More so, the project announced a militia establishment at a large event that only expected the senior officials. This announcement meant that the scheme was trustworthy and supported by the government.

The collapse of the scheme happened in December 2015. The peer to peer lending company stopped trading anymore with the investors leading to an investigation by the police. The company’s assets were all frozen for the investigation to be conducted (Lam, 2018). The Xinhua News Agency declared that about 98 percent of the company’s investment was all fake. The agency further found out that the scheme was targeted to enrich the founders of the companies. By the beginning of 2016, at least 21 organizers of these pyramids’ schemes had been arrested. Six million documents of these companies were unearthed from the ground by the use of excavators. This scheme threatens the country’s financial system. Like other pyramid schemes, Ezubao company fabricated fake products for investment and used funds from the new investors to pay back the old investors. The scandal turned out to be one of the biggest fraudulent Ponzi schemes in the history of china.

The ant sales scheme was also another pyramid scheme that reached western media headlines. The ant sale scheme was a Chinese pyramid scheme that was built on an anthill foundation in 1999 (Herold, 2008). The program was created around purportedly dead ants that were traditionally claimed to heal many diseases such as bossing one immunity and increased male stamina. During the scheme’s inauguration, investors were made to pay 10000 yuan for two boxes full of ants. The investors were expected to feed these ants until they died. With the death of the ants, the firm would peak as it was expected that it would use the dead ants to make medicines. In return for their investment, the investors were promised 13,250 Yuan.

The scheme attracted many investors as the founders went beyond employing famous stars to market their products on the TVs. The project also announced that it had advanced to a modern high-tech form that combined advanced technologies with traditional cultures to preserve people’s health. Further, Wang, using his political clout (Zhao, Kou, Peng, & Chen, 2018), the programme made several contributions to the charity groups. Therefore, the scheme gained trust from potential investors when it received awards for the production of beneficial products. Approximately 80.000 companies were already selling these products. Investors, especially from low backgrounds, saw this as an opportunity to redeem their economic state. According to the scheme originators,’ the company enjoyed a 15 billion yarn profit annually from 1 million people who bred the ants per year (Feng, Sun & Gong, 2019)

.          The scheme, which was a big success for the country, hit a blow in 2004. The food and drug administration body in the US banned importing these products, claiming that they were substandard. That same year in 2004, the company failed to make its payments to its investors for the first time (Fei et al., 2020). This brought a lot of street chaos. People blamed the government for allowing these fraudulent projects to be operated for years and demanded their money. About 36000 citizens lost approximately $400 million to these schemes.

However, after investigation, later on, the prosperity of the pyramid scheme could not be ascribed exclusively to the naiveness of the investors who took to breeding ants. The founder, Wang, was found to be running other successful companies that were parallel to these schemes. His charitable and public-spirited nature conceived the investors into believing that the investment was real. More so, sources stated that he had never been sited with other politicians in the media, which made him more reliable and trusted. The whole scheme seemed so real and legitimate, a skill which other pyramid schemes play to lure investors.

Since them China has been in a constant fight against these businesses. In 2018, about 80 people were arrested for participating in a fraudulent pyramid scheme that had over 200,000 investors.  The project was busted with $1.50 billion. Earlier in the same year, another 2 people were given a life sentence after they were caught with fraud. The 2 were arrested with 19 others who were imprisoned for 12 years. China started a campaign in an effort to put an end to the pyramid schemes. However, despite the efforts to take down all these businesses, they continue to grow at a faster rate than the authorities can hold. Businesses in China are applying more tactful ideas and some moving them into online platforms.


Comparison between China and Albania

When a fraud pyramid scheme is discovered, the China and Albania government hold the individuals involved accountable under the SEC enforcement plan. Since the failure of the famous pyramid schemes in these two countries, extensive regulatory measures and efforts have been taken to reduce the likelihood of the reoccurrence of other such schemes. Investigation processes in the countries are faster than they previously were. The governments also adopted policy measures and implement tracking systems that track any fraud dealers.

The following are characteristics and ways in which the two countries have dealt pyramid schemes:

Impairment of the financial sector.

The pyramid schemes impact the financial sector negatively in both China and Albania. First, the pyramid schemes consumed the savings made by the investors. These investments would have been more successful if they had been made in other legit financial institutions such as banks and would significantly raise the country’s Gross domestic product (Gjika, Ll & Zaçaj, 2018).  Moreover, the establishment of these schemes discredited other financial institutions. In Albania, for example, the governor of Albania’s bank tried to warn people about the consequences of investing in the Albania pyramid scheme. However, the high-interest rates offered by the pyramid scheme presented is a more profitable company as compared to other financial institutions.

Economic impairment

Undoubtedly, pyramids and Ponzi schemes have one character in common in these two countries. They are illegal and not considered as legitimate investments by their governments. This is due to the previous downfalls that the two countries have experienced from past pyramid schemes. Large financial losses have been incurred and tremendously impaired the economies. Both China and Albania economies experienced the impacts of pyramid schemes in the marketplace, and the victims involved lost thousands of money to the schemes.  Losing millions impacted on the economy as people lost confidence to engage in other legitimate investments.

Fraudulent chameleons

From the description of the leaders’ nature from the Albania pyramid scheme and the ant sale scheme in China, one could hardly think of better words to describe them but trained expert fraudsters that are empowered. For example, the ant sale scheme was operated by a well-known Wang, who had full support from the government. On the other hand, the Albanian pyramid scheme had full support from the government since some of the government members were already investing in this scheme. This explains why the Albania government was reluctant to heed to the warning sent by the world bank.

Crime investment

Without a doubt, the two jurisdictions treat pyramid schemes as crimes and scams. Since the collapse of the three grand pyramid schemes in the two countries, governments label other similar schemes formed as fraud companies. Both governments have raised the public’s awareness of the critical effects brought about by these schemes. These governments no longer support such projects. Instead, individual investors are held liable, and they are no longer protected through any financial regulations. The government perceives them as gamblers. However, this has posed a challenge to the investors since reputable schemes come up dressed as legitimate companies that are licensed, raising no suspicions from the investors. Most of the time, these reputable schemes are not easy to detect until they fail. In case of a loss and following the government distancing from these schemes, individuals who suffer such losses bear all the consequences.

Forceful Government changes

Pyramid schemes cannot be run forever. Even if the whole world were to join, those at the bottom of the system would experience losses. These losses led to Albania’s rebellion of 1997. From the two countries, government policies have had to change after the collapse of the pyramid schemes. Initially, both governments supported the programs as they also benefited from them. However, governments have recognized those schemes as frauds and put up policies that illegalize these schemes. In China, the government announced a nationwide crackdown and mentioned pyramid schemes as the main promoters of human trafficking alongside other gambling activities.

Civil unrest and violence

In 2004, riots broke out in the streets after the collapse of the anthill scheme. In Albania, at least 2000 cases of deaths were reported following the violence caused by the failure of the Albanian pyramid scheme. People were disappointed by these schemes that promised high returns prompting several violent incidents as people rioted and demanded the return of their money. Thousands of investors had invested in these pyramid schemes. They blamed the government for lack of law enforcement measures that would have regulated the excessive growth of the pyramid schemes. In Albania, the riots led to the arrest of the pyramid organizers. The two governments were forced to enforce measures that stopped the running of these pyramids.

Assets recovery

Recovery of investors’ money is one of the most critical steps to take after a pyramid collapse. The two governments put up measures to which some of the investors’ money would be refunded if not all. By the time of the collapse, the operators of these schemes have squandered all of the investments made by the citizens for gifts and lavish lifestyles. The Xinhua News Agency reported that the Ezubao operators used this money for gifts. More so, investigators traced all the assets and unearthed some documents from the soil.

Development of financial systems

With the collapse of the pyramid schemes, governments developed the role that is played by financial and non-financial institutions in an attempt to combat these pyramids schemes (Jusufi, 2017). The banks were more open about their business flows to encourage investors to participates in investing in the banks. More public awareness was also spread among the participants and the public.