Ponzi schemes and pyramid schemes: how to identify unknown investment scams

In all investments, from buying Bitcoin to participating in initial coin offering (ICO) programs, investors are usually faced with two difficult questions: what is my return on investment (ROI) and how much risk am I taking? These questions become critically important, especially considering that many investors inadvertently fall into Ponzi schemes that continue their dangerous activities in various forms.

Background of Ponzi schemes and how they actually work

The Ponzi scheme is named after Charles Ponzi, an Italian-born swindler who moved to North America and became famous for his fraudulent financial system. In the early 1920s, his scheme managed to deceive hundreds of naive investors and continued for eight months to a year of ongoing fraud.

Ponzi schemes are inherently simple but effective scams. Experts say it is an investment illusion, with the main strategy of paying profits to earlier investors using the money received from new investors. The problem is that the newest investors are never paid anything.

How does this work in practice? Suppose a scammer takes $1,000 from the first investor and promises to return it with 10% interest after 90 days. The first 90 days pass quickly. The scammer finds two new investors and collects $1,000 from each. Now, he pays the first investor $1,100 (initial investment + promised 10% interest), using part of the $2,000 collected from the two new investors. The first investor is satisfied and reinvests.

The scheme continues as follows: the funds from new investors are used to pay the promised returns to earlier investors. The scammer does this by convincing new victims with attractive promises to join. But for the system to keep going, it needs a constant influx of new investors. Eventually, it runs out—there are no more people with enough money to invest, the scammer cannot make the promised payments, and either disappears or gets caught.

Pyramid schemes structure and how they differ from simpler scams

A pyramid scheme (also called pyramid fraud) works a little differently. Here, the company leader, for example “Alice,” can earn money in multiple ways: not only from her own recruits but also from those recruited by her recruits.

Suppose the scammer offers Alice and Bob the opportunity to buy the company’s marketing rights for $1,000. Now they have the right to sell marketing rights themselves and earn commissions on each new member they recruit. The $1,000 from their sales is split with the initiator—$500 to Alice and Bob, and $500 to the scam.

To recoup their initial investment, Alice and Bob need to sell at least two additional marketing rights packages, so they can get back their original $1,000. The same obligation applies to their recruits. The system requires continuous recruitment—more and more people putting in money.

A critical point about pyramid schemes is that most of them do not offer any real product or service. They survive solely on the money from new members. Some pyramid schemes disguise themselves as legitimate multi-level marketing (MLM) networks. These may indeed offer services, but often only as a cover for the scam.

Ponzi scheme vs pyramid scheme: similarities and key differences

Both systems are forms of financial fraud that attract investors with the promise of quick, high profits. Both also require a continuous inflow of new investor money to operate and continue. Usually, neither system provides real value in the market—no products or services.

But the fundamental differences are:

In a Ponzi scheme, the activity is presented as an investment management service. Participants believe their profits come from legitimate investments. In reality, the scammer simply steals money from one person to pay another. Money does not grow or multiply—it just shifts.

In a pyramid scheme, earning money is based on network growth. Participants must recruit new members to earn money. Each participant is motivated to expand their network. The structure requires each “investment” to be made before the money flows upward to the organizers.

How investors can protect themselves

If an investment opportunity seems too good to be true, it’s likely a scam. Here are practical steps every investor can take:

First—be skeptical. An investment promising quick and high returns with minimal income is always suspicious. Moreover, if something seems complicated and hard to understand, that’s a red flag.

Second—avoid all suddenly promoted opportunities. For example, an unexpected invitation to a long-term investment program often signals danger.

Third—research the seller and provider. Trustworthy financial advisors, brokers, and brokerage firms are registered and monitored by regulatory authorities. Their documentation is publicly available.

Fourth—check registration information. Legitimate investment opportunities are legally registered. The first question should be: “How can I verify the registration information?” If the opportunity is not registered, the provider must give a clear and objective explanation.

Fifth—make sure you understand the investment. Never invest money in something you do not fully understand. Use all available resources and be very cautious, especially if the investment opportunities are secretive.

Sixth—report. If investors identify a Ponzi scheme or pyramid fraud, they should immediately report it to the relevant authorities. This helps protect future investors from the same scams.

Is Bitcoin itself a pyramid scheme?

Finally, an important clarification: some claim that Bitcoin is a giant pyramid scheme. That is not true. Bitcoin is simply money—a decentralized digital currency protected by mathematical algorithms and cryptographic mechanisms, which can be used to buy goods and services.

Like fiat money (legal tender issued by governments), cryptocurrencies can be used in virtually all contexts—legally and illegally. Money can be used in Ponzi schemes, in grants, and in legitimate transactions. This does not mean that money itself is a scam. Bitcoin is a technology and a tool—what truly determines the risk is how people use it.