What Is a Pyramid Scheme?

A pyramid scheme is a sketchy and unsustainable business model, where a few top-level members recruit newer members. Those members pay upfront costs up the chain to those who enrolled them. As newer members in turn recruit underlings of their own, a portion of the subsequent fees they receive is also kicked up the chain. Often called "pyramid scams," these operations are illegal in some countries.

How Pyramid Schemes Work

Pyramid schemes are so named because they resemble a pyramid structure, starting with a single point on top, that becomes progressively wider toward the bottom.

Let's assume the following: Founder Mike sits alone at the top of the heap, represented by the number "one." Assume Mike recruits 10 second-tier people to the level directly below him, where each newbie must issue him a cash payment for the privilege of joining. Not only do those buy-in fees funnel directly into Mike's pocket, but each of the 10 new members must then recruit 10 tier-three members of their own (totaling 100), who must pay fees to the tier-two recruiters, who must send a percentage of their takes back up to Mike.

According to the hard-sell pitches made at recruitment events, those bold enough to take the pyramid plunge will theoretically receive substantial cash from the recruits below them. But in practice, the prospective member pools tend to dry up over time. And by the time a pyramid scheme invariably shuts down, the top-level operatives walk away with loads of cash, while the majority of lower-level members leave empty-handed.

It should be noted that because pyramid schemes heavily rely on fees from new recruits, the vast majority do not involve the sale of actual products or services with any intrinsic value.

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Video credits: TED ED