Most investors who decide to invest in Bitcoin or any other cryptocurrency for the first time, or in an initial coin offering (ICO) usually focus on two things. First, the return on investment (ROI) represents their final profit from their initial investment. Second, the risks involved in investing. When the risk is too high, investors risk losing their initial investment capital (partially or completely), which results in a negative return on investment.

Of course, any investment carries a certain level of risk. However, if investors are accidentally involved in informal investment scams, such as Ponzi or pyramid schemes, the risk is greatly increased. Therefore, it is very important for investors to be able to identify and understand how these scams work.

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What is a Ponzi scheme?

Ponzi Scheme – Named after Charles Ponzi. Charles Ponzi was a famous Italian fraudster who later emigrated to North America and became known for his fraudulent methods.

In the early 1920s, Ponzi defrauded hundreds of victims in total, and his deception ran successfully for over a year. Basically, a Ponzi scheme is a fraudulent investment tactic that works by paying back early investors by taking money back from new investors. The result of this type of scam is that investors end up getting paid nothing at all.

The working examples of Ponzi schemes are as follows:

  • Fraudsters get $1,000 from investors. He promised to repay the initial investment, plus 10% interest, after 90 days of the predetermined period.
  • During this promised 90-day period, the fraudsters seek out two other investors. Then, collecting funds from each of the two investors, the fraudster would pay the $1,100 promised by the first investor out of the $2,000 received from the two new investors. At the same time, the fraudster may also encourage the first investor to reinvest the $1,000.
  • In this case, by continuously acquiring funds from new investors, it can be used to pay the promised returns of early investors, and can persuade them to invest again with confidence, and invite more people to participate in the investment.
  • As the system develops, the fraudster needs to find more new investors to join the scheme, otherwise, he cannot pay the promised return on investment.
  • Ultimately, the scheme became unsustainable and the fraudsters either absconded with huge sums of money or were caught.

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What is a pyramid scheme?

Pyramid schemes (or tiered sales) are a common business operation that seeks to recruit more new members into a program with the promise of a fee or bonus.

Take a case:

The fraudster pitches Alice and Bob to buy the company’s distribution rights for $1,000. After the purchase, Alice and Bob also have the right to sell the distribution rights themselves at a profit. A share of every additional member sale they manage to recruit must be shared with the promoter. Divided from the $1,000 collected at a 50/50 profit split.

In the above scenario, Alice and Bob would have to triple their sales to break even. Because of the profit distribution system, they make a profit of $500 on a sale instead of $1,000. If so, their next customer will also bear more sales pressure to balance the initial investment because of this system. It also required more members to achieve, and the plan eventually collapsed and lost its continuity. Pyramid selling is also illegal because of its unsustainability.

Most pyramid schemes do not provide products or services and are only sustained by funds raised by recruiting new members. But there are also pyramid schemes that are considered legal to sell services or products. Such as multi-level marketing companies, known as (MLM). But often this is done just to hide potential fraudulent activity. So, many MLM companies with potentially questionable ethical selling practices are using the pyramid model, but not all MLM companies are fraudulent.

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Ponzi scheme versus pyramid scheme:

Similarity:

Both are financial forms of fraud that convince victims to invest by promising good returns.

Both require regular inflows of capital from new investors to remain active and successful.

Often, none of these scams offer real products or services.

Difference:

Ponzi schemes are often marketed as investment management services, where investors assume that the returns they receive are the result of legitimate investments. But basically rob one party to pay the other.

Pyramid schemes are more network marketing in nature and require investors to recruit new members to make a profit. Therefore, each participant receives a commission before paying the money to the top of the pyramid.

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How to protect yourself?

Be skeptical. Investment opportunities with small investments and quick returns can be dishonest. Especially investing in things that are unfamiliar or difficult to understand. If it sounds too good to be true, it’s probably a scam.

Beware of unsolicited but unexpectedly invited long-term investment opportunities, often a red flag.

The seller and the investment background should be investigated. Find a reputable financial advisor, broker or brokerage firm. Find a credible registered governing body or an oversight investigation.

Don’t believe it lightly. Verification is required. Only invest in legally registered institutions. The first action is to ask for registration information. In the case of an unregistered investment opportunity, you should be questioned and asked for a reasonable explanation.

Make sure you understand what you want to invest in right now. You shouldn’t invest in something you don’t fully understand. Be sure to make the most of available resources and be cautious about confidential investment opportunities.

Whenever an investor encounters a pyramid scheme or a Ponzi scheme, it must be reported to the relevant authorities. This will help protect future investors from falling victim to the same scam.

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Is Bitcoin a Pyramid Scam?

Some people may think that Bitcoin is a great pyramid scheme, but it is not. Bitcoin is a kind of money. It is a decentralized digital currency, protected by computerized and encrypted security technology, which can be used to purchase goods and services. Just like fiat currencies, cryptocurrencies can also be used for pyramid schemes (or other illegal activities), but that doesn’t mean that cryptocurrencies or fiat currencies are pyramid schemes.

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