Financial pyramid
| Financial pyramid |
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A financial pyramid is a structure where each level of the pyramid relies on the level below it for support. It is most commonly used when referring to a Ponzi scheme, where each layer of the pyramid uses funds from the layer above it to pay out promised returns, while hoping to recruit a new layer of investors below it to provide the same support.
The structure of a financial pyramid typically includes:
- A base layer, which is the first to be recruited and consists of the initial investors.
- A second layer, which is the next to be recruited and consists of those who are promised a return of the initial investment plus an additional return.
- A third layer, which is the next to be recruited and consists of those who are promised a return of the second layer's return plus an additional return.
Example of Financial pyramid
The most famous example of a financial pyramid is the Ponzi scheme, which was created by Charles Ponzi in the 1920s. In this scheme, Ponzi promised investors a return of 50% on their investments in just 45 days. He then used money from the new investors to pay off the returns of the old investors, while also taking a cut for himself. This cycle of recruitment and promise of returns continued until the pyramid collapsed, leaving all investors at the top of the pyramid with a loss.
In conclusion, a financial pyramid is a structure where each level of the pyramid relies on the level below it for support. It typically consists of multiple layers of recruitment and promise of returns until the pyramid collapses and all of the investors in the top layers of the pyramid lose their money. The most famous example of this is the Ponzi scheme, which was created by Charles Ponzi in the 1920s.
Types of Financial pyramid
Financial pyramids can take a variety of forms, such as:
- Ponzi schemes, where money from new investors is used to pay out promised returns to earlier investors.
- Multi-level marketing schemes, where money from new recruits is used to pay out promised returns to earlier recruits.
- Pyramid selling schemes, where money from new recruits is used to pay out promised returns to earlier recruits.
In all of these cases, the structure of the financial pyramid is the same: each level of the pyramid relies on the level below it for support. As more new recruits join the scheme, the pyramid grows larger and more unsustainable until it eventually collapses.
To summarize, a financial pyramid is a structure where each level of the pyramid relies on the level below it for support. It is most commonly used when referring to a Ponzi scheme, where each layer of the pyramid uses funds from the layer above it to pay out promised returns, while hoping to recruit a new layer of investors below it to provide the same support. Financial pyramids can take a variety of forms, such as Ponzi schemes, multi-level marketing schemes, and pyramid selling schemes. When the pyramid can no longer recruit or pay out promised returns, it collapses and all of the investors in the top layers of the pyramid lose their money.
Steps of Financial pyramid
A financial pyramid is structured in the following steps:
- The base layer is the first to be recruited and consists of the initial investors. They are promised a return of the initial investment plus an additional return.
- The second layer is the next to be recruited, and they are promised a return of the base layer's returns plus an additional return.
- The third layer is the next to be recruited, and they are promised a return of the second layer's returns plus an additional return.
- This process continues until the pyramid reaches its peak and can no longer recruit or pay out promised returns.
At this point, the pyramid collapses and all of the investors in the top layers of the pyramid lose their money. The investors in the lower layers may still get some of their money back, but the higher up the pyramid an investor is, the less likely they are to get anything back.
In summary, a financial pyramid is a structure where each level of the pyramid relies on the level below it for support, and each layer is promised a return of the previous layer's returns plus an additional return. Eventually, the pyramid will reach its peak and collapse, and all of the investors in the high levels of the pyramid will lose their investments.
Disadvantages of Financial pyramid
- Financial pyramids are highly risky and often unsustainable. As the pyramid grows, it relies on an ever-increasing number of investors to sustain it, which can't be guaranteed.
- They are also illegal in many countries and can lead to severe legal repercussions for those involved.
In conclusion, financial pyramids can provide investors with a quick return on their investment, as well as a large potential return, but come with a high degree of risk. As such, they should be approached with caution and only undertaken if the investor is aware of the risks involved.
Other limitations of Financial pyramid
- It is unsustainable as it is not able to generate new money
- It relies on others to make investments and is therefore vulnerable to external shocks
- It is illegal in most countries and can lead to severe penalties if caught
- It is not transparent as it obscures the identities of those involved
- It is a form of fraud as it relies on false promises of returns
- Leverage: Leverage is the use of borrowed funds to increase the return on the investor's own money. Leverage can be used to either increase the return on an individual's investments or to increase the size of the financial pyramid.
- Pyramid Selling: Pyramid Selling is the process of recruiting new investors to join the financial pyramid. Pyramid Selling involves promising a return to the investors, which is higher than the return that is being paid out to the investors in the previous layer.
- Compounding: Compounding is the process of reinvesting the returns from the investment in order to increase the total return. Compounding can be used to increase the size of the financial pyramid, as well as the returns generated by the pyramid.
In summary, Financial pyramid is a structure which is commonly used in Ponzi schemes, where each layer of the pyramid uses funds from the layer above it to pay out promised returns, while hoping to recruit a new layer of investors below it to provide the same support. Other related approaches include leverage, pyramid selling and compounding, which can be used to increase the size of the financial pyramid and the returns generated by it.
Suggested literature
- Jarvis, C. (2000). The rise and fall of the pyramid schemes in Albania. IMF staff papers, 47(1), 1-29.
