How Ponzi Schemes Work- --- Ponzi Schemes vs. Pyramid Schemes

How Ponzi Schemes Work
by Josh Clark & Jane McGrath Money | Scams
Ponzi Schemes vs. Pyramid Schemes

­Many people associate Ponzi schemes with pyramid schemes. While they do share some similarities, they're not exactly the same. If you think about the organization and methodology behind a Ponzi scheme, it certainly has a triangular structure. The schemer sits at the top, above continually increasing rungs of investors. However, there are fundamental differences between how classic pyramid schemes are carried out and how Ponzi schemes are executed.



The essential difference between a pyramid scheme and a Ponzi scheme is that a Ponzi schemer will only ask you to invest in something. You won't be asked to take any more action than handing over money. He or she will claim to take care of the rest and give you your returns later. The Ponzi schemer is the mastermind behind the whole system and is always shuffling money from one place to another.

On the other hand, a pyramid schemer will offer you an opportunity to make the money yourself. It requires more work, though: You have to buy the right to start a franchise and start recruiting more people like yourself. The recruits will often pay the recruiter a cut of their profits. You can read How Pyramid Schemes Work to understand more about that process.

The difference may seem slight, but one point to keep in mind is that unlike pyramid schemes, Ponzi schemes are always illegal [source: Walsh]. Some legitimate businesses, such as Mary Kay and The Pampered Chef, have been built around the pyramid idea. But the nature of a Ponzi scheme necessarily relies on securities fraud. It involves deceit to convince someone to invest money that won't actually be invested.

Nevertheless, some people continue to use the terms interchangeably, and many texts classify Ponzi schemes as a type of pyramid scheme. And, of course, when you're the victim of one, the difference probably seems insignificant.

Next, we'll take a look at some other real-life Ponzi schemers.
Lucky Victims

Some victims make out pretty well in a Ponzi scheme. Although later investors certainly lose money, the early investors can come out ahead. Their testimonials are exactly what help perpetuate the scheme. Some unscrupulous characters invest with the full knowledge that they're funding a Ponzi scheme -- they cross their fingers that they aren't in the bottom rung. Of course, any money they make is at the expense of other investors. Legal questions abound as to whether these lucky initial investors should be forced to help recoup losses for later investors [source: Berenson].