Sergey Kondratenko: Financial Fraud, Pyramids and Scams

Sergey Kondratenko: Financial Fraud, Pyramids and Scams

Regulators and businesses are actively fighting against the growing manifestations of fraud and financial crimes. According to fintech expert Sergey Kondratenko, the most common types are scam projects and pyramids, which investors most often fall for. According to him, the development of digital banking and the acceleration of digital payments contribute to financial fraud.

According to a PYMNTS study, in 2022, the number of financial institutions experiencing an increase in fraud cases increased by 43%. The average cost of fraud cases for financial organizations with assets greater than $5 billion increased by 65%, from $2.3 million to $3.8 million in 2023.

In response, financial institutions and businesses are stepping up efforts to find ways to counter the increase in fraudulent transactions and, consequently, financial losses.

Sergey Kondratenko: Features of financial pyramids and their mechanisms

A financial pyramid is a business strategy characterized by an unstable organizational model. In such a model, profit is not generated by the sale of real goods or services, but by the investments of new participants.

“The peculiarity of a financial pyramid is that new participants must make an initial payment to join the system,” explains Sergey Kondratenko. “The funds received are used to pay profits to the first investors. In return, newcomers are promised a profit if they manage to attract even more participants to the system.”

But this type of system is very fragile and often does not last long. Profits are not generated by real economic activity but by attracting new investments.

It should be noted that each financial pyramid has its own structure, principles and methods of attracting new participants. Sergey Kondratenko proposes to consider the main schemes of financial pyramids and the principle of their operation.

The single-level pyramid is the simplest scheme, called a Ponzi scheme. In this case, the organizer issues securities without real support and attracts investors. At the same time, he pays income to the first participants at the expense of the funds of new participants. However, such a system will collapse when the promised profit is not enough for all investors.

A multi-level pyramid is already more complex and involves attracting new participants not only to invest but also to invite others. The more levels there are, the more profitable those at the top become. However, with the decrease in the number of potential newcomers, such a pyramid is doomed to collapse.

The eight-ball model represents an attempt to circumvent established stereotypes and hide the pyramidal nature of the system. Here, each participant is required to attract only two new customers, which seems easier and more accessible, but still retains a pyramid structure.

The matrix system, according to Sergey Kondratenko, is even more complex and consists in forming cells with a certain number of participants who then move to new levels. They achieve this by attracting new customers and receiving bonuses.

Sergey Kondratenko: Concept and signs of financial fraud in business

Fraud in a company is the theft of an organization’s assets or falsification of financial statements in order to deceive stakeholders. According to Sergey Kondratenko, stakeholders are people or organizations whose interests are related to the success of the company.

These are usually investors and owners, that is, those who have invested their funds in the business in the hope of future profit.

A pyramid scheme can infiltrate a business in a variety of ways, often by masquerading as legitimate investment opportunities or business models. Here are some examples of where this can happen:

1. Offer of “internal investments”: employees or managers can propose to their colleagues to invest in a project within the company, which is in reality a pyramid. This can be disguised as a business project or a startup.

2. Partnerships with external companies: The company may partner with external organizations that operate pyramid schemes. These organizations may present their business as a lucrative investment proposition or an innovative business project.

3. Employee Incentive Programs: Pyramid schemes can be integrated with employee incentive programs where employees receive a reward for bringing new members (colleagues) into the system.

4. Seminars and training: Organization of training or motivational seminars, which are in reality a means of spreading pyramid schemes among employees.

5. Disguising as training or corporate development: Offering “unique” personal or professional development opportunities that require employee investment but are actually based on a pyramid model.

The expert explains that corporate frauds are usually committed by employees of the company and mainly harm the company and its owners. These acts involve false information, breach of trust and abuse of authority.

Where the risk of corporate fraud is highest:

1. Investment projects. This sector is often associated with high risks of fraud due to the large investment volumes and the complexity of the projects. Fraud can occur at the project evaluation stage, with dishonest risk assessment or abuse of power in decision-making.

2. Construction of equipment. Here too, the risk of fraud is high, particularly due to inflation in the cost of materials and work, as well as falsified contracts. Corruption and bribery are also common in this area.

3. Cash financial transactions. Cash transactions are one of the most vulnerable forms of fraud because they are the most difficult to track and control.

4. Purchasing and procurement. The risk of fraud in this area includes not only corruption and bribery, but also manipulation of the cost of goods and services, as well as the creation of fictitious suppliers.

5. Sales. Fraud risks in this area include misrepresenting products or services and using fraudulent schemes to increase sales or commissions.

6. Charitable organizations (non-governmental organizations). Despite its noble objectives, this sector is also exposed to risks related to misuse of funds, fictitious programs and breach of donor trust.

Each of these sectors requires specific precautions and controls to minimise the risks of fraud. The assessment and management of these risks must be based on in-depth analysis and the implementation of appropriate verification mechanisms and transparency systems.

Sergey Kondratenko believes that corporate fraud poses a serious threat, especially to large companies.

Ponzi scheme: features and principle of operation – Sergey Kondratenko

As the expert points out, the name “Ponzi scheme” comes from the name of Charles Ponzi, who in the early 20s of the 20th century became famous for using a similar fraudulent scheme.

“A Ponzi scheme is a form of financial fraud in which attackers deceive investors. They promise depositors high returns or payments that are actually provided by new participants integrated into the system. However, these payments are not provided by real income or profits, but depend on the money of new participants. This allows the system to continue to operate and attract new investors until the flow of new funds no longer covers payments to old participants. This ultimately leads to the collapse of the entire system,” explains Sergey Kondratenko.

The mechanism of a Ponzi scheme can be described in the following sequence:

1. Register the platform and attract the first customers.
2. Continuation of the search for new victims.
3. Reinvestment of income.
4. End of payments.

This is a fraudulent campaign that works like a Ponzi scheme. It continues its activities as long as it manages to maintain the appearance of a stable business. As soon as customers stop investing money, the scammers withdraw the funds already invested and start a new project. The original company closes its doors and it becomes almost impossible to recover the funds.

Sergey Kondratenko on the crypto pyramid model
A crypto pyramid is a fraudulent investment scheme in which income is paid to existing investors from the funds of new participants.

According to Sergey Kondratenko, it is called a “pyramid” because there are usually a large number of new participants at the bottom of the hierarchy, with each subsequent level containing fewer investors.

To understand the crypto pyramid model, the expert gives the following example:
Project-Y creates a crypto pyramid and asks five people to invest 1 bitcoin each. It promises to give each participant 2 bitcoins back every month. Project-Y needs 10 bitcoins to keep its promise, so it recruits five or more other people whose investment will ensure that the first group of investors is paid back. This forms the second level of the pyramid, where five more people each contribute 1 bitcoin.

Project Y can now pay 2 bitcoins to each of the participants in the first tier, but it still needs 10 bitcoins. So it invites more people, creates a third tier, and so on.
Sergey Kondratenko emphasizes that this process continues until the search for new investors becomes impossible and the system collapses. A similar end awaits all financial fraud schemes that operate on the pyramid principle. They all lead to the loss of participants’ money and the collapse of the project.

Investors should be especially vigilant to avoid investing in fraudulent projects and pyramid schemes, which can lead to significant financial losses. It is important to carefully analyze and verify the legitimacy of projects, studying their history, the reputation of the organizers and the reality of the promised income. Projects that offer unusually high returns in a short period of time should be avoided, as this is often a sign of fraud. It is always wise to consult financial experts and use information from reliable sources. Investing should be based on transparency and caution to protect your assets from fraudulent schemes.