Have you ever heard the phrase “if something seems too good, it probably isn't”?
These phrases could be interpreted as ways to prevent a Forex pyramid scam, a form of trading fraud where everything seems legal and shiny until reality falls under its own weight; the scammer ends up in jail and the participants bankrupt.
Do you want to know how pyramid scams work and if Forex can be included in this category?
What is a pyramid scam?
A pyramid scam is a form of fraud in which participants recommend a product that offers high returns to other participants, who must recommend and attract (refer) new customers in exchange for a commission.
The new income allows paying the interests of the investments already established and multiply the business.
Looking at the definition, it is possible that the concept of pyramid scam is related to Forex, but is it really so? Let's see how this pyramid scam system came about and how it works first.
History of Pyramid Scams
|"Although there are several precedent cases, the Italian scammer Carlo Ponzi is often regarded as the creator of the pyramid scam, also known as the Ponzi scheme." - source: dotbig.com.
Carlo Ponzi was a lower-class Italian immigrant who came to the United States in 1919. Having few resources, he had to find different ways to make money, and he would soon discover that Italian immigrants sent coupons to their families via postal mail. Redeemed at the destination.
Due to the strong depreciation of local currencies due to the ravages of World War I, when redeemed, the coupons provided an average return of approximately 10%. So there was a real deal with arbitration between geographies.
A numerical example of this scheme
A person buys a coupon worth 100 dollars in the US, paying in euros at a 1 to 1 exchange rate, that is, for 100 euros, he gets a coupon valued at 100 dollars and sends it to Italy where relatives can do it. Turn into.
The banking system is not globalized, and in Europe, 1.1 euros are being paid for every dollar. By exchanging the coupon that has been purchased in the US for 100 euros, you receive 110 euros in Europe, that is, a return of 10%.
Realizing this business opportunity, Ponzi set up a company called Securities Exchange Company, whose function was to distribute coupons, promising profits of 50% after 45 days or 100% after 3 months.
The scheme only worked if the new investors brought in money. When no new investors could be found and the old ones cashed in, the scheme collapsed.
Before long, people were queuing up and trusting him with their savings, but Carlo Ponzi wasn't buying coupons; he was using the latest investors' money to pay interest. The first investors obtained the return of the promised investment, and the fame of Carlo Ponzi multiplied. Before long, he had to hire agents, paying generous commissions for every dollar raised.
In February 1920, Ponzi earned an income of $5,000, equivalent to $65,000 today. The fame did not stop growing, and in March, he already had $ 30,000 and began to expand his business to other states. Nobody wanted to be left out of this scheme offered by someone who looked like a financial genius and who even warned against fraudulent investments.
By May 1920, it had already raised $420,000, and by July, it had millions, but it had attracted too much attention. Finally, on July 26, 1920, the business model was questioned, and the State took over the company.
Initially, some investors claimed their money, and Ponzi returned it to them, regaining popular support, but in August 1920, the banks and the media declared Ponzi bankrupt.
He himself later confessed that in 1908 he had been part of a very similar scam in Canada, which offered investors large returns.
How the Pyramid Scam works
The pyramid scam works because the creators manage to convince participants that it is an attractive and safe investment, a bargain they have found in the market and that no one has discovered until now.
Each participant recommends the product and attracts new customers to the network, increasing the height and size of the pyramid.
It is surely easier to understand with an example of how to create a pyramid scam:
Interest rates are currently at historic lows. Imagine that an investor offers you a safe investment of 1,000 euros that offers 5% interest.
In addition, it indicates that, for each person you or your new clients attract, you will obtain a bonus of 10% of their investment.
You may be suspicious of where so much money is coming from, for which the creator will have developed an economic model convincing enough to offer a credible and succulent hook, where people bite.
Keep in mind that all investments involve risk, and the promises of such "safe" investments are suspect in themselves, in addition to the seemingly high returns they promise.
Later we will include examples of some of the most famous pyramid fraud scams in history, both in Spain and globally.
Now suppose that:
- An investment of 1000 euros is required to enter the scheme, which will report an annual profit of 5%.
- A 10% commission is paid for each referral.
- This model has worked, and, for simplicity, at all times, each participant has recruited 2 people until 14 floors of the pyramid have been filled.
With all these data and those of the previous statement, the following table has been prepared:
Table: own elaboration. A numerical example of a pyramid scheme. Held on June 7 at 11:30 am CET.
According to this model, the creator and main fraudster will obtain 10% of all the money entered, 819,200 euros. The components of the second step will obtain half since they have recruited 2 people who in turn have continued to recruit, granting a succulent passive income.
Those on the 13th floor of this investment will have invested 1000 euros, and expect to earn 5%, although for referring this investment to two people, each group will charge 200 euros. That is a 25% return on investment.
The last group, at the moment, has only entered the money and expects to obtain a 5% profitability.
The total income of this scheme reaches 16.38 million euros, and the expenses will be the sum of 5% of the deposits and, the commissions, a total of 11.47 million euros.
➤ According to the example, the cash position of the pyramid scam after one year of life would be 4.9 million euros. If new members are not recruited, the interest could continue to be paid for 6 more years.
The key to the pyramid scheme is that participants do not request a refund of the initial amount.
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