What is a pyramid scheme and how does it work?

In accordance with paragraph 14 of article 7 of the Law of August 23, 2007 on combating unfair market practices, unfair and therefore illegal is under any circumstances a misleading market practice, which consists in creating, launching and promoting promotion systems. Pyramid schemes in which a consumer performs a service in exchange for the opportunity to receive material benefits that depend primarily on the inclusion of other consumers in the system, and not on the sale or consumption of goods.

This provision, which essentially copies the definition of a pyramid scheme from Directive 2005/29/EC of the European Parliament and of the Council of May 11, 2005, more or less tells us what the essence of the project is. However, let’s try to explain the concept of a financial pyramid more clearly.

It is no coincidence that they are called a pyramid, because at its top there is usually one person - the creator, and at subsequent, lower levels there are more and more involved people who have less and less in common with the organizer.

Each subsequent person entering the pyramid causes all those above it in the pyramid (i.e. all those who entered the system faster) to earn money from this person and the benefits he contributed. Therefore, each participant is interested in attracting more and more new people.

In a financial pyramid, the funds that come from such new people are usually not invested in any assets, but simply distributed within the higher levels of the system.

However, its viability depends on a constant influx of new members. As long as this results in new funds entering the pyramid and they exceed the profit paid by the participants, the system works. However, this does not last forever. It is possible that the acquisition of new funds will be constantly at the same level, and the participants in the pyramidal structure will not pay the profit due to them.

Examples of financial pyramids

Financial pyramids can take a variety of forms. These forms are best illustrated by a few historical examples of phenomena of this kind.

Albanian financial pyramids

An exceptional example that probably shows most clearly how far reaching the practice of a pyramid scheme can be. After the political changes in Albania in the 1990s, Albanians had nowhere to invest their money. This was due to the fact that financial institutions in the local market were just being formed. In such conditions, a number of quasi-banks were created, operating on the principle of financial pyramids, offering various investments with different returns. All these entities, without exception, collapsed, causing financial losses to the people of Albania, estimated at about $1.2 billion. After these events, the Albanians took to the streets, demanding the return of invested funds. The riots eventually led to a change of government as well as several hundred deaths.

Sberbank Safe Lech Grobelny

In an era of political change, also in Poland, a company was created that promised high profits, but turned out to be a financial pyramid. The interest rate on deposits (which were officially referred to as investment loans provided by clients) at Lech Grobelny’s Bezpieczna Kasa Oszczędności in 1989 was much higher than at competing banks. The interest rate reached 300%. and was supposed to come from trading in US dollars.

Such activities were carried out by currency exchange offices, which were led by Lekh Grobelny, the owner of Sberbank “Safe”. When the loan came due, Grobelny went abroad, and the vast majority of the money simply melted away. The owner blamed the then authorities (in particular, the then Deputy Prime Minister and Minister of Finance Leszek Balcerowicz), who suppressed the then-raging inflation in Poland and prevented further currency speculation.

amber gold

Probably the most famous Ponzi scheme in Poland based on a company claiming to be the first precious metal depository in our country is, of course, Amber Gold. Deposits with an interest rate of 6 percent. in the case of investments in silver - up to 15 percent. with a special deposit in gold and keeping the investment for a period of 36, 48 or 60 months, they have proven to be very profitable for many people. At first glance, they may not seem very suspicious - especially to people unfamiliar with financial markets and investing.

Amber Gold LLC, which offered attractive financial instruments, did not, however, have any banking permits. To keep the pyramid running for as long as possible, the company used tricks to dissuade customers from withdrawing their funds (including outrageously high commissions for early withdrawals). Ultimately, Amber Gold collapsed, and the prosecutor’s office estimated the losses caused by its activities at PLN 851 million.

Is ZUS a pyramid scheme?

Sometimes you can hear the controversial thesis that the first, mandatory pillar of the Polish pension system is a financial pyramid. This is true?

Not quite, although the principle of its work really resembles a financial pyramid. The first pension pillar, based on the Social Insurance Institute, is a generic contract based on contributions. These contributions, which are paid by currently employed Poles, are not saved in ZUS, but are paid immediately to current pensioners.

In a sense, this structure of work can resemble a financial pyramid, especially since if it were not for the current subsidies from the state budget, this system would not be able to function in this way for a long time due to the deteriorating demography of our country and the constantly aging society.

However, it should be noted that the name of the system on which the pensions of the majority of Polish pensioners are based, despite some prerequisites for such a name, can certainly cause negative emotions, so we do not encourage it.

Can you go to jail for participating in a pyramid scheme?

By itself, the payment of money to the financial pyramid, except for the possibility of their early loss, as a rule, should not give rise to any other negative consequences.

Under section 24a of the Unfair Competition Act of April 16, 1993, the organizer of an avalanche sale (this is a special type of pyramid scheme) and the person who operates such a system is liable to imprisonment for a term of 6 months to 8 years. (so is the one who convinces other people to join him).

The organizer of the financial pyramid itself can also be punished under part 1 of article 171 of the Law of August 29, 1997 “Law on banks”. This provision refers to the unauthorized accumulation of funds of other persons in order to provide loans, cash loans or otherwise encumber these funds with risk, for which the act is punishable by a fine of up to PLN 20 million and imprisonment for up to 5 years. .

An additional fine of up to PLN 5 million may be imposed (in accordance with article 178 of the Law of July 29, 2005 on trading in financial instruments) for trading in financial instruments without the required permit or authorization. The organizers of financial pyramids very often do not have such, since with this type of activity (even well hidden) it is not always possible to get them.

How to protect yourself from participating in a financial pyramid?

Taking into account the principle of operation of financial pyramids, as well as the unpleasant consequences that can befall their participants (especially those involved in attracting and recruiting new participants), it is worth knowing how to protect yourself from participating in such a procedure. Here are some tips:

1. Beware of ads that promise huge sums of money if you pay a small “buy-in” to get started;

2. Avoid any kind of business where your profit depends only on the funds that new users will pay;

3. Carefully analyze the proposals of institutions that promise an above-average return on investment - in particular, check whether the institution is trustworthy and how the money you deposited will be reinvested;

4. Remember that for almost every investment there is a universal rule: “the greater the profit, the higher the risk”;

5. Don’t go into investments that you don’t understand and that simply can’t tell you how the profits will be made.