A pyramid or Ponzi scheme lures investors by ostentatiously paying out vast returns to a handful of people and promising similar windfalls to new investors.

But rather than earning money through investments, it funds its payouts by recruiting an ever-increasing army of new investors whose money flows up to the original investors. When the scheme inevitably collapses, the most recent investors lose everything.

The methodology was demonstrated in the women-only “gifting” craze popular in Britain a few years ago.

Investors in schemes such as Women Empowering Women had to hand over a “gift” of £3,000 and then recruit two more gifters, each of whom would then recruit two more in an ever-broadening pyramid.

They were promised £24,000 in return for their £3,000.

The prospect of acquiring money for free was heady and became the talk of the Isle of Wight, where a large number of victims were concentrated. “It wouldn’t be exaggerating to say you could walk down the high street of Newport and see groups of people talking about it,” said Richard Stone, a local trading standards inspector.

At the time, the trade department pointed out the flaw in the promise, advising potential recruits there was no guarantee they would get their money back as the scheme relied on an endless supply of recruits.

The department said: “Consideration of the mathematics shows it may not work for the majority of participants. For each of eight investors to receive £24,000 for their £3,000, it needs a further 64 people to invest. The 64 would need 512 investors, the 512 would need 4,096 participants and so on. Eventually the supply of potential recruits will dry up, leaving most people in the scheme with nothing.”

The schemes were able to operate outside investment laws because the investors were technically offering gifts. The figure of £3,000 was well chosen: this is the threshold above which gifts become liable for tax.

The 2005 Gambling Act and consumer protection legislation introduced this year have made such schemes illegal, but in October there were reports of a pyramid trying to get off the ground in Bristol and south Wales.

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