Where the payouts come from
Any income comes from somewhere: selling a product, providing a service, or lending money. The first thing a pyramid scheme does is remove that question from the conversation. Instead of a source of income, you're shown the result: a chart, a payout screenshot, a friend who has already cashed out.
There is only one source: contributions from people who joined after you. The payout to the first participant is made from the money of the second and third. The scheme was named after Charles Ponzi: in 1920 in Boston, he promised investors quick profits from international postal coupons, but hardly any coupons were bought, and old investors were paid with new investors' money.
Money comes from outside: someone paid for a product or service. New investors speed up growth, but revenue does not disappear without them.
Money comes from inside: people who joined later pay. Stop recruitment, and there is nothing to pay out at the very next payout.
That is why a pyramid scheme never has a weak quarter. It has only two states: inflow is growing or the scheme no longer exists.
Why collapse is built into the structure
To pay the earlier participants, inflow must outpace payouts, so each new round of participants has to be larger than the last. If everyone brings in 6 people, by the seventh round you already need several tens of thousands of people, and a few rounds later the count reaches billions. You run out of people before you run out of money.
How many people are needed in each new round if everyone brings in 6
Usually, it never gets that far. Recruitment only has to slow down: payouts start being delayed, someone asks for their contribution back, word spreads, and everyone comes for their money at once. That is how MMM ended in Russia in 1994. In Albania, similar schemes had drawn in a significant share of the population by 1996, and after their collapse in early 1997, unrest spread across the country.
A scenario, not a measurement: the week inflow stopped - first small delays, then no payouts at all
Why early participants sincerely invite friends
Early participants really do receive payouts. They do not need to lie: right beside you is a real person with real experience and real money. That is what makes these schemes resistant to warnings - you do not trust statistics, but you trust someone you know. They are not an accomplice; they simply joined closer to the beginning.
It is harder to tell than it seems: many of these schemes have a real product, sometimes even a decent one. Look not at the product, but at where the participant's income comes from: sales to outside customers mean retail; contributions and mandatory purchases from people they recruited mean a pyramid scheme in disguise.
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Sources
- Charles Ponzi, Boston, 1920. The collapse of pyramid schemes in Albania is analyzed in an IMF working paper (C. Jarvis, 1999)