Reviewed by Julius Mansa
Fact checked by Kirsten Rohrs Schmitt

A pyramid scheme is a fraudulent investment where participants make money primarily by recruiting new investors rather than from legitimate businesses.

Technology and terminology have evolved from penny stocks to crypto assets and from arbitrage AI to smart contracts. The fundamental deception hasn’t changed much since the 1920s, however, when Charles Ponzi claimed to have his own breakthrough arbitrage technique for postal reply coupons. Early investors are paid with funds from recruits, creating an unsustainable cycle that inevitably collapses.

Key Takeaways

• A pyramid scheme funnels earnings from all recruited participants on the lower levels of an organization to participants on higher levels.
• It’s a felony in the U.S. to recruit participants into pyramid schemes.
• These schemes rely on income from recruitment fees not from selling actual goods or services with real value as many participants believe.
• Multilevel marketing operations (MLMs) are legitimate business programs in which distributors earn money from the sale of tangible goods and commissions on their recruited distributors’ purchases and sales.
• Pyramid schemes often masquerade as MLMs but their focus is on fees from recruits not revenue from product sales.

A Pyramid Scheme Example

People across the U.S. received an offer from a brokerage in 2023 and 2024 to invest with a crypto trading bot that could generate 13.5% monthly returns. The investment seemed tailor-made for the moment. It leveraged the power of the hottest tech (artificial intelligence or AI) to profit from one of the hottest assets (crypto). If what amounts to 354% annual returns seemed too good to be true, it was, according to the U.S. Securities and Exchange Commission (SEC).

The SEC froze the assets of two brothers who allegedly orchestrated the $60 million scheme in August 2024 by promising investors astronomical returns through cryptocurrency arbitrage trading. There was no bot, no trading, and no legitimate business, however. One brother had already been convicted of securities fraud. It was just an elaborate pyramid scheme that funded luxury condos and recreational vehicles with new investors’ money.

Important

Some publications differentiate Ponzi schemes from pyramid schemes, leaving room for legal forms of the latter, but Investopedia follows federal law enforcement and the SEC which stick to using the word “scheme” for illegal activities.

How Pyramid Schemes Work

A pyramid scheme operates through a simple but deceptive principle: Participants pay to join what they believe is a legitimate investment opportunity but their returns come solely from recruiting new investors, not from any actual business activity or investments. The schemes usually collapse when a snag is hit or recruits run out.

Modern pyramid schemes often add sophisticated elements to appear legitimate. Various operators have defrauded investors of billions with claims of leveraging the power of AI, proprietary algorithms, exclusive trading platforms, or special access to high-yield investments. These technological trappings serve one purpose: to disguise the age-old fraud beneath.

These schemes have become increasingly sophisticated, often masquerading as cutting-edge investment opportunities in cryptocurrencies, AI, or other emerging technologies. The SEC has warned investors of a surge in such cases. Crypto-related pyramid schemes represent the fastest-growing category of fraud investigations.

“The SEC will use all tools at its disposal to stop those who exploit the excitement around new technologies to defraud investors,” said Justin C. Jeffries, Associate Director of Enforcement in the SEC’s Atlanta Regional Office.

Warning

The worrisome part about modern pyramid schemes isn’t just their size. It’s their velocity. Social media can help these schemes collect millions in days, not months or years. The money is often gone before anyone realizes it’s a fraud.

Stages of a Pyramid Scheme

A pyramid scheme typically unfolds in five stages.

1. The setup

Operators present an investment opportunity that promises unusually high returns, often 10% or more monthly. They may claim that these returns come from cryptocurrency trading, foreign exchange, real estate, or other investments that sound plausible but complex enough to discourage too many questions.

2. Early success

Initial investors often receive the promised returns that are paid with money from newer recruits. These early “winners” unwittingly become marketers for the scheme, enthusiastically telling friends and family about their success. Social media has been used to amplify these testimonials, drawing in even more victims.

The pyramid schemes of the 2020s exploit “tech plausibility.” People know some investors are getting rich from AI and crypto but they don’t know how. The targets of these frauds are therefore primed to believe that there’s money to be made. The operator doesn’t need a brilliant knowledge of the technology, just enough to make their story fit what most people think they know.

3. Warning signs appear

Even the most successful pyramid schemes reveal telltale warning signs before their inevitable collapse. The first red flag is a shift in how these schemes handle money. Withdrawal requests that were once processed smoothly are constantly delayed. Operators typically blame these hiccups on technical issues, bank problems, or regulatory compliance.

Communication also shifts noticeably. Operators who were once highly responsive are suddenly nowhere to be found. Updates arrive less often and they often come with changes to terms of service or new withdrawal requirements when they do.

4. Desperation hits

The operator soon begins using common tactics like mandatory “holding periods” for funds or minimum investment increases. Some schemes pressure existing investors to lock up their funds for longer periods in exchange for supposedly higher returns.

Perhaps the most revealing warning sign is a ramp-up in recruitment. Operators typically pressure existing members to bring in fresh capital as the pool of potential new investors shrinks. They might introduce special bonuses for recruitment or create artificial urgency through limited-time offers. These schemes have even gamified the process, creating elaborate point systems or recruitment contests to maintain momentum.

5. The inevitable collapse

The scheme can no longer sustain payments to earlier participants as the pool of new investors shrinks. The entire structure collapses when recruitment slows or stops. The operators have usually extracted millions in funds by this point, leaving most participants with substantial losses.

Why They’re Called Pyramid Schemes

The term “pyramid scheme” comes from the exponential growth pattern that’s required to sustain these frauds. Each level of investors must recruit multiple new investors, creating a pyramid shape that mathematically guarantees eventual collapse.

The pyramid quickly becomes unsustainable if each participant must recruit five new investors to earn their promised returns:

• Level 1 (Top): 1 operator
• Level 2: 5 investors
• Level 3: 25 investors
• Level 4: 125 investors
• Level 5: 625 investors
• Level 6: 3,125 investors
• Level 7: 15,625 investors
• Level 8: 78,125 investors
• Level 9: 390,625 investors
• Level 10: 1,953,125 investors

The scheme would need more participants than exists in the entire U.S. population by level 13. It would exceed Earth’s population by level 15. This mathematical reality explains why pyramid schemes inevitably collapse. They eventually run out of potential recruits.

But let’s say that each person recruits just two people, not five. Here’s a chart of how this works out:

Ponzidemia and Modern Pyramid Schemes

A review of pyramid schemes worldwide reveals how these scams adapt to local conditions. Argentina has been undergoing what locals dub a “Ponzidemia” in the mid-2020s. It’s facing government austerity and growing desperation among the population years into an economic crisis: an epidemic of pyramid schemes targeting a population that’s struggling with triple-digit inflation and deep recession.

Scammers hired Polish actors to pose as American executives in one case that grabbed the nation’s attention. They presented a fake crypto investment app called RainbowEx to lure in people from all over Argentina. They were particularly successful with residents of San Pedro, a town of 70,000 people.

The scheme promised 2% daily returns paid in cryptocurrency, an appealing prospect in a country where more than half the population lives below the poverty line and no one trusts the local currency. Almost a third of the town’s residents invested, losing an estimated $49 million when the scheme collapsed.

Warning

Recent cases show that fraudsters aren’t just emailing or otherwise communicating with people. They’re creating fake platforms and apps to make their schemes seem all the more plausible.

Argentina’s “Ponzidemia” even has links to the Argentine president Javier Milei who has gained a worldwide following of those sympathetic to his libertarian views. Milei was promoting the CoinX platform across his social media accounts just before beginning a campaign that would take him to the country’s highest office. The ads claimed that investors would receive 8%-per-month gains. Returns were to be paid in U.S. dollars, making the pitch even more appealing.

The platform is still under investigation for fraud.

Bernie Madoff: The New Face of Pyramid Schemes

Bernie Madoff operated what remains the largest and most notorious pyramid scheme in history before he died in prison in 2021. Unlike flashier frauds promising astronomical returns, Madoff’s genius lay in his restraint. He promised steady 10% to 12% annual returns regardless of market conditions. This seemingly modest but consistent performance attracted wealthy individuals, charities, and other investment firms.

Madoff helped create the Nasdaq exchange and he exploited his reputation as a Wall Street pioneer and his position as a pillar of the philanthropic community to sustain his fraud for decades. He claimed to use a complicated “split-strike conversion strategy.” No actual trading occurred. He simply paid old investors with new investors’ money instead.

The scheme couldn’t outlast the 2008 financial crisis and it collapsed in December of that year. The scale was staggering: $64.8 billion in paper wealth vanished, devastating thousands of investors, including many charities and foundations. Madoff’s crimes gained him a 150-year prison sentence and his name became a virtual synonym for pyramid schemes like Ponzi before him.

How to Spot Pyramid Schemes

The SEC and Argentine cases illustrate many of the commonalities among modern pyramid schemes. These red flags have remained remarkably consistent even as the schemes themselves have evolved from postal coupons to crypto trading bots.

• No genuine product or service: Operators may talk about advanced trading algorithms or über-secret investment strategies but they can rarely explain exactly how they generate returns. The so-called strategy isn’t even attempted in most cases.
• Guaranteed high returns: Promises of specific, unusually high returns like “13.5% monthly” or “2% daily” are classic warning signs. Legitimate investments acknowledge market risks. Only fraudsters guarantee profits.
• Emphasis on recruitment: You’re likely stuck in a pyramid scheme if your earnings depend more on recruiting others than on actual product sales or investment returns. Modern schemes often disguise this element as “network expansion” or “community building.”
• Complex commission structures: Legitimate businesses have clear, straightforward revenue models. Pyramid schemes often have elaborate multilevel payment structures that are designed to obscure their true nature.
• Pressure to “act fast”: Fraudsters often create artificial urgency, claiming limited spots or special “founder” rates. This pressure tactic aims to prevent potential victims from conducting due diligence.

Pyramid Schemes and Multilevel Marketing

Multilevel marketing (MLM) is a legal method of doing business. This business model involves the sale of actual goods or services by distributors or participants in the MLM. Distributors are paid for the products and services of the MLM that they sell. They can also receive income from sales made by distributors they’ve recruited and from the people those recruits then bring in.

Some pyramid schemes disguise themselves as MLMs. The Federal Trade Commission warns people to take note of and avoid MLM promoters who do any of the following:

• Make extraordinary claims of enormous earning potential
• Try to persuade people that recruiting others is where the real money lies
• Pressure people to get involved without learning more about the company
• Make it clear that an opportunity will be lost unless people get in immediately

Another warning sign is seeing existing distributors continue to buy products they can never sell so they can qualify for some kind of reward.

Are Pyramid Schemes Illegal in the United States?

Yes. It’s a felony crime to recruit any person to take part in a pyramid scheme in the U.S. Penalties include prison, fines, and disgorgement.

How Do Pyramid Schemes Succeed?

The success of pyramid schemes is usually limited to founders and early-stage members. These people attract new, fee-paying members who are eager to make a promised quick and large monetary return. These members then recruit more fee-paying members and the cycle continues. The income flows up to the founders and earlier members.

Are Pyramid Schemes the Same As Multilevel Marketing Programs?

No. MLMs are legal businesses whose distributors earn money from the sale of actual products and from commissions on products sold by distributors they recruit. Pyramid schemes sometimes pose as MLMs, however, to attract people who are likely to want to work with the MLM model.

The Bottom Line

Pyramid schemes represent one of the oldest forms of financial fraud but they continue to evolve and adapt to exploit current trends and technologies. These schemes share the same fatal flaw: they require an endless chain of new investors to survive. From Ponzi to Madoff to crypto scams, the pattern remains unchanged: Early investors are paid with new investors’ money until the inevitable collapse.

Knowing the warning signs and underlying mathematics of these schemes is crucial for protecting yourself. When someone promises guaranteed high returns through complex or proprietary methods, remember that no amount of technological sophistication can overcome the fundamental math that makes pyramid schemes unsustainable. The best protection remains due diligence and the prudence to understand that if something sounds too good to be true, it probably is.