More and more users are considering all sorts of cryptocurrencies as a great investment for the future. They often come across offers to participate in investment schemes to make money from crypto-assets. Such schemes frequently hide the principle of a financial pyramid or a Ponzi scheme, which are structurally similar and differ only in minor details. Let’s look at the principles of these two “investment schemes,” their similarities and differences.

Ponzi Scheme: Basic Principle of Operation

Pyramids and Ponzi Scheme for Making Money on Crypto

This scheme was first applied by Charles Ponzi from Italy. At the beginning of the 20th century, he established the Securities Exchange Company, by means of which he actively used the investment scheme in North America, involving hundreds of depositors in it. 

Ponzi promised investors quarterly dividends amounting to 50% of invested funds. The commission payments were generated by funds coming from new depositors. Eventually, he was accused of fraud since not everyone could get dividends from the invested funds. Ponzi spent five years in prison for the swindle, and the Securities Exchange Company was declared bankrupt. Below is an example of the practical application of the Ponzi scheme.

  1. The organizer finds the first investor, who invests money in exchange for the promise of a quarterly dividend payment of 50% of the investment.
  2. At the end of the stipulated period, the organizer pays out the promised investment, but at the same time, actively seeks new investors whose funds are used to pay the dividends.
  3. As the scheme gathers momentum, the organizer encourages old investors to make new investments.
  4. Sooner or later, the investment scheme collapses as the inflow of new funds drops, and it is not possible to provide payouts to all investors. At this point, the organizer either disappears with all the deposits or is criminally liable for the scam.

There are real cases in the crypto industry where Ponzi schemes have been used. In May 2020, Chinese law enforcement authorities took into custody the organizers of Wotoken, which involved a Ponzi scheme. Wotoken was positioned as a smart online crypto wallet that automatically generated profits. The fraudsters managed to collect roughly the following amounts of crypto-assets:

  • 46,000 BTC; 
  • 684,000 EOS;
  • 2,000,000,000 ETH; 
  • 56,000 BCH;
  • 292,000 LTC.

Wotoken closed in October 2019 after 15 months of operation. According to the investigation, the organizers raised a total of more than $1 billion in investments from more than 715,000 people. 

What Is a Pyramid Scheme?

Pyramids and Ponzi Scheme for Making Money on Crypto

A pyramid scheme, otherwise known as a financial pyramid scheme, is also actively used by fraudsters in 2022. As a rule, for joining a financial pyramid, investors are promised a high percentage of the deposit and an additional percentage for each new participant. In practice, the pyramid scheme is implemented in the following way:

  • the organizer offers participants to become part of the investment scheme by investing a certain amount of money;
  • after the first payments, investors actively invite new participants, convinced by their own experience that the “scheme works”; 
  • the referral program is an additional motivation to involve new participants, i.e., profit for each attracted investor;
  • the more new investors appear in the pyramid, the higher the profit of the original investors.  

As in the Ponzi scheme, the pyramid inevitably collapses because it eventually reaches its peak, and the number of depositors begins to decrease. Moreover, the organizer can withdraw funds from investors and shut down the project without waiting for it to collapse. There are known cases when such schemes were used by fraudsters in the cryptocurrency industry as well. 

For example, in September 2021, BitConnect received a lawsuit from the US Securities and Exchange Commission (SEC). BitConnect was accused of creating a major fraud scheme using BTC. The scheme’s organizers promised investors commissions for Bitcoin deposits. A large-scale advertising campaign was organized on YouTube and social networks. Promoters received a percentage of profit for each investor they attracted. According to the SEC, the total turnover of funds by the time BitConnect closed was more than $2 billion. 

Many investors didn’t receive the promised income and lost their deposited assets. While the exact whereabouts of BitConnect creator Satish Kumbhani remain unknown to this day, the SEC continues its legal battle with several promoters involved in the fraudulent scheme.

Ponzi and Pyramid Schemes: Similarities and Differences

Pyramids and Ponzi Scheme for Making Money on Crypto

In structure, the Ponzi scheme is similar to the pyramid scheme. However, there are certain differences. The main similarities between Ponzi and pyramid schemes include the following:

  • the schemes require a constant inflow of new investors to remain effective;
  • these schemes often do not offer real products or services to investors, only financial investments;
  • both schemes are originally fraudulent.

If we talk about the main differences between Ponzi schemes and pyramid schemes, they are insignificant. Generally, in a Ponzi scheme, the organizer personally invites new investors, while in a pyramid scheme, the participants can also attract new investors.

To avoid becoming a victim of scammers, users should carefully study the organization’s business model in which they are supposed to invest money. The main question is, what generates profit?

How Not to Fall into the Trap of Scammaers

Pyramids and Ponzi Scheme for Making Money on Crypto

First of all, you shouldn’t be quick to agree to tempting investment proposals. Even if the scheme seems profitable, it is better to conduct an additional study of this issue, namely:

  • carefully examine the project’s investment conditions; for example, what percentages of income are promised and how this income is formed;
  • find out information about the project organizers, whether they are registered with the regulatory authorities or have the appropriate licenses, etc.;
  • check the protection of investors and the legality of the process of attracting investment; it is always necessary to study the legal side of the issue with which the scammers, as a rule, have problems; 
  • carefully look into all questions and don’t invest in something that is not completely clear even if you study it thoroughly. 

It is worth considering that scammers continue to actively use cryptocurrencies to organize all sorts of scams. This is due to partial anonymity in crypto transactions and the inability to undo operations. Also, note that the concept of cryptocurrency projects is in no way similar to the principles of pyramid or Ponzi schemes. Most crypto projects are built on decentralized blockchain networks with strong data protection systems, although they are not 100% safe from the influence of hackers who can hack into software code, double-spending attacks, and other activities aimed at appropriating other people’s assets.

Author: Evgeny Zatsepin
#Cryptocurrency #Scam