"A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, usually without any product or service being delivered.

Pyramid schemes are illegal in many countries, including the United States, Great Britain, Malaysia, Norway, Australia and New Zealand."

"A Ponzi scheme usually offers abnormally high short-term returns in order to entice new investors. The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going.

"The system is doomed to collapse because there are little or no underlying earnings from the money received by the promoter. However, the scheme is often interrupted by legal authorities before it collapses because a Ponzi scheme is suspected and/or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases.

"The scheme is named after Charles Ponzi, who became notorious for using the technique [in 1920]. Today's schemes are often considerably more sophisticated than Ponzi's the underlying formula is quite similar and the principle behind every Ponzi scheme is to exploit lapses in judgement arising from investor naivety.

"An advertisement is placed promising extraordinary returns on an investment - for example 20 per cent for a 30-day contract. The precise mechanism for this incredible return can be attributed to anything that sounds good but is not specific: 'global currency arbitrage', 'hedge futures trading', 'high-yield investment pro-grammes', 'offshore investment', or something similar.

"With no proven track record for the investors, only a few investors are tempted, usually for smaller sums. Sure enough, 30 days later, the investor receives the original capital plus the 20 per cent return. At this point, the investor will have more incentive to put in additional money, and, as word begins to spread, other investors grab the 'opportunity' to participate. More and more people invest, and see their investments return the promised large returns.

"The reality of the scheme is that the 'return' to the initial investors is being paid out of the new, incoming investment money, not out of profits. There is no 'global currency arbitrage', 'hedge futures trading', or 'high-yield investment programme' actually taking place. Instead, when investor D puts in money, that money becomes available to pay out 'profits' to investors A, B, and C. When investors X, Y, and Z put in money, that money is available to pay 'profits' to investors A through W.

"One reason that the scheme initially works so well is that early investors - those who actually got paid the large returns - quite commonly reinvest (keep) their money in the scheme (it does, after all, pay out much better than an investment). Thus, those running the scheme do not actually have to pay out very much (net) - they simply have to send statements to investors that show how much the investors have earned by keeping the money in what looks like a great place to get a high return. They also try to minimise withdrawals by offering new plans to investors, often where money is frozen for a longer period of time, for example 50 per cent return per month for one year. They then get new cash flows as investors are told they could not transfer money from the first plan to the second.

"The catch is that at some point one of three things will happen: 1) the promoters will vanish, taking all the investment money (less payouts) with them; 2) the scheme will collapse of its own weight, as investment slows and the promoters start having problems paying out the promised returns (and when they start having problems, the word spreads, and more people start asking for their money, similar to a bank run); 3) the scheme is exposed because when legal authorities begin examining accounting records of the so-called enterprise, they find that much of the 'assets' that should exist, do not." Source