FINANCIAL PYRAMIDS IN FINANCIAL SYSTEM
Financial pyramid is described as a structure in which the participant’s profit depends on later payments from other people who are lower in the structure of the pyramid. For its existence, there is a constant inflow of new participants demanded, which means that in the long-term it is always doomed to failure[1]. A cruder description can be found in the study of U.S. Securities and Exchange Commission (SEC), according to which the financial pyramid is an investment fraud, which assumes the payment of alleged profits to existing investors from funds brought in by new investors[2]. According to FBI’s description, money is collected from newly admitted individuals to pay off liabilities to previous creditors and thus eliminate the risk of suspicion by clients about the institution’s insolvency or the illegality of the venture[3]. Thus, the pyramid lasts if the inflow of funds from new clients exceeds the sum of payments to existing customers (including interest).
There are always two elements in the structure of the financial pyramid:
- Ini
- Recruitment of participants is often done by a person cooperating with the initiator and who, in his/her own example, shows potential participants that the venture gives a chance for real profit.
In the literature there are descriptions of various types of pyramids, among which the most popular are the classifications[4]:
- a) according to the criterion of income activity
- actively investing money according to the contracts with clients,
- actively investing money but not according to the contracts with clients,
- not investing funds obtained from clients.
- b) according to the criterion of the type of connections with clients
- constant increase in the number of clients recommended by others (vertical structure),
- lack of connections between clients (flat structure);
- c) according to the criterion of the distribution network
- with own network of service points,
- as an internet network.
- d) according to the territorial range of action criterion
- local,
- national,
- international.
- e) according to the openness of functioning criterion
- as an open institution, known on the financial market,
- as a closed institution, only for discretionary entities.
Financial pyramids are generally considered as a pathology of the financial market, but when we look a little bit more carefully at the activities realized by public institutions, we can ascertain that some of them have similar construction. One such example seems to be repartition pension insurance system (PIS).
In this system pensioners receive their pensions only thanks to current inflows from people working at the same time. Such description is like the one of financial pyramid. But comparison of features of these two forms allows us to see important differences (tab. 1).
Table 1. Financial pyramid vs. Pension insurance system (PIS)
| Feature | Financial pyramid | Pension insurance system |
| initiator | private | public |
| participants | unrestricted | determined by law (pensioners and workers) |
| rules of joining the contract | voluntary | obligatory |
Source: own elaboration
Financial pyramids can be different according to several criteria, but considering pension insurance system as an example of financial pyramid it can be ascertained that:
- according to the criterion of income activity this is the one which is not investing funds obtained from clients (but it’s made legally in accordance to the contract which is in fact a statutory regulation);
- according to the criterion of the type of connections with clients there is a lack of connections between clients (flat structure), everyone pays independently from the others.
- according to the criterion of the distribution network it’s monopolized by the state with own network of service points,
- according to the territorial range of action criterion it’s national,
- and according to the openness of functioning criterion it’s an open institution, known on the financial market and strongly regulated.
Considering the construction of financial pyramid, it can be concluded, that in PIS like in financial pyramid money is collected from regular payments from working individuals to pay off liabilities to pensioners. These people are participants while the state is the initiator. It’s only its permission that guarantees functioning of PIS and law obligation that force people to pay contributions. Otherwise, people could have resigned from participating in such a system and chosen a more profitable way of investing money. So, in fact, only this element – obligatory participation – sustains system activity. Probably, workers while left with free choice wouldn’t be so interested in paying money for other’s benefits with a very dubious promise of being paid in future by younger participants of society. But since pension insurance system is legal, can’t be named a financial pyramid.
Bibliography:
- Masciandaro, E. Takáts, B. Unger, Black finance. The Economics of Money Laundering, EE Publishing, Cheltenham 2007.
- Masiukiewicz, Piramidy finansowe. Teoria, regulacje, praktyka. PWN, Warszawa 2015.
- Pachucki, Piramidy i inne oszustwa na rynku finansowym. Poradnik klienta usług finansowych, KNF, Warszawa 2013.
[1] M. Pachucki, Piramidy i inne oszustwa na rynku finansowym. Poradnik klienta usług finansowych, KNF, Warszawa 2013, s. 6.
[2] P. Masiukiewicz, Piramidy finansowe. Teoria, regulacje, praktyka. PWN, Warszawa 2015, s. 14.
[3] Ibidem, s. 15.
[4] Ibidem, s. 17-18.
