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Crypto Law/Level IV · Holders' traps/4.2 Scams the law sees/Lesson 6

Ponzi schemes and guaranteed yield

How Ponzi schemes pay old investors with new money, how crypto versions have been charged, why a guaranteed yield is a legal and practical warning sign, and what happens to money paid out before a collapse.

Education, not legal, tax or investment advice. Crypto law differs between countries and states and changes often. Check the current rules where you live with a qualified lawyer or tax adviser before you act.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. Free pre-deposit check: ask where the yield comes from and whether the offering and seller are registered (Investor.gov, BrokerCheck); guaranteed or unusually steady returns are SEC red flags, and unregistered investment contracts lack securities protections.
  2. Keep a dated ledger of every deposit and withdrawal; your net position decides both clawback exposure (Cunningham v. Brown; 11 U.S.C. §548, two-year reach-back) and the deductible loss.
  3. If the operator is criminally charged, Rev. Proc. 2009-20 (as modified by 2011-58) lets you deduct 95% of the net qualified investment, or 75% if pursuing third-party recovery; write the procedure’s name on Form 4684 and attach its statement.
  4. Without a charged lead figure the safe harbor is unavailable (IRS CCA 202511015); the ordinary §165(c)(2) theft-loss rule still applies, deductible when no reasonable prospect of recovery remains.

MaterialsThe SEC’s Investor.gov page ‘Ponzi Scheme’, with its list of red flagsCunningham v. Brown, 265 U.S. 1 (1924), the Supreme Court case arising from Charles Ponzi’s bankruptcySEC press releases 2013-132 (Shavers), 2021-172 (BitConnect) and 2022-134 (Forsage)Your own record of every deposit into and withdrawal from any yield product you have used

Wonder

  1. How can a scheme pay real returns for months if it is a fraud?
  2. Is promising a high fixed yield illegal in itself?
  3. If I was paid out before the collapse, can I be made to give the money back?

Explore

  1. The SEC defines a Ponzi scheme as an investment fraud that pays existing investors with funds collected from new investors. The organisers promise high returns with little or no risk, but often invest nothing and keep some of the money. With little or no real earnings, the scheme needs a constant flow of new money and tends to collapse when recruiting slows or many investors try to cash out at once. Early investors who are paid on time become its best advertisement. A pyramid scheme is a close relative, in which participants are paid mainly for recruiting others rather than from any underlying business.
  2. The name comes from Charles Ponzi. The Supreme Court described his scheme in Cunningham v. Brown (1924). Starting in December 1919 with $150, he borrowed money on notes promising $150 for every $100 within 90 days, spreading a false story that he profited from buying international postal coupons in one country and selling them in another. He paid his 90-day notes in full after 45 days to build excitement. Within eight months he took in $9,582,000 and issued notes for $14,374,000. He made no investments of any kind, and the Court said he was always insolvent, becoming more so the more his business succeeded.
  3. Crypto versions follow the same arithmetic. In 2013 the SEC charged Trendon Shavers with running a bitcoin Ponzi scheme that promised up to 7 percent weekly interest and raised at least 700,000 bitcoin. In September 2021 it sued BitConnect and its founder, alleging that a ‘lending program’ supposedly powered by a trading bot defrauded retail investors of $2 billion, while its top US promoter pleaded guilty in a parallel criminal case. In August 2022 it charged the founders and promoters of Forsage, alleging a pyramid and Ponzi scheme run through smart contracts that raised over $300 million. SEC complaints are allegations until proved or settled.
  4. A guaranteed yield matters legally as well as practically. When people hand over money expecting profits from someone else’s efforts, the arrangement is often an investment contract, and so a security subject to registration and anti-fraud rules (lesson 1.2.3). The SEC’s red flags include returns promised with little or no risk, overly consistent returns regardless of market conditions, unregistered investments, unlicensed sellers, secretive strategies, and difficulty cashing out, sometimes met with offers of even higher returns to stay put. The FBI has described crypto schemes guaranteeing 1 to 3 percent a day. A high yield is not proof of fraud, but its source should always be explainable (lessons 2.2.5 and 4.1.4).
  5. When a Ponzi scheme collapses, money already paid out may not be safe. In Cunningham v. Brown, investors who rushed to get repaid in the scheme’s last days had to return the money to Ponzi’s bankruptcy trustees. The Court held that all the victims were creditors in the same position and that the circumstances ‘call strongly for the principle that equality is equity’; the repayments were unlawful preferences. Modern bankruptcy trustees and receivers rely on similar reasoning when they seek money back from investors who were paid out, especially those who received more than they put in (lesson 4.3.6). Being paid does not make an investor a winner.
  6. Tax rules have a special route for Ponzi losses. Rev. Proc. 2009-20, as modified by Rev. Proc. 2011-58, gives a safe harbour for deducting theft losses from a fraudulent arrangement, but only where the lead figure has been charged with a state or federal crime or is the subject of a state or federal criminal complaint; IRS Chief Counsel Memorandum 202511015 confirmed that it does not cover scams whose operators were never identified or charged. A practical check: before depositing, ask where the return comes from and whether the offering or seller is registered, and keep records of every deposit and withdrawal, because your net position matters for both clawbacks and tax.

Key facts

  • The SEC defines a Ponzi scheme as an investment fraud that pays existing investors with funds collected from new investors.
  • In Cunningham v. Brown, 265 U.S. 1 (1924), the Supreme Court found that Ponzi took in $9,582,000 in eight months and issued notes for $14,374,000.
  • Cunningham v. Brown held that Ponzi investors repaid shortly before bankruptcy had received unlawful preferences, applying the principle that equality is equity.
  • In 2013 the SEC charged Trendon Shavers with a bitcoin Ponzi scheme that promised up to 7 percent weekly interest.
  • In September 2021 the SEC sued BitConnect and its founder, alleging a fraudulent offering that took $2 billion from retail investors.
  • In August 2022 the SEC charged 11 people over Forsage, alleging a crypto pyramid and Ponzi scheme that raised more than $300 million.

Exercise nine, six, three, one

9CollectList up to 9 features of an investment or yield offer you have seen, such as the promised rate, how stable it is, who pays it, lock-up rules, referral bonuses, registration and how withdrawals work.
6ClusterSort them into 6 categories: size of return, consistency of return, source of return, recruitment incentives, registration and licensing, and access to your money.
3DistillReduce the 6 categories to 3 questions that would most quickly separate a real source of yield from new investors’ money.
1CrystallizeWrite 1 sentence explaining, in your own words, why receiving payments from a scheme does not prove the scheme is genuine.

Fact check

Dates, figures and claims checked against the published sources listed below.

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