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Banking and Finance

Texas Man Admits to $4.5 Million Bitcoin Ponzi Scheme

 In what is widely believed to be the first Ponzi scheme involving virtual cryptocurrency Bitcoin, a Texas man pleaded guilty to one count of securities fraud in a scheme that raised nearly $5 million in Bitcoin from investors who were promised astronomical annual returns of over 3,500%. Trendon Shavers, who turned 33 today, entered the plea before U.S. District Judge Lewis Kaplan. Shavers is scheduled to be sentenced on February 3, 2016, and his plea agreement with prosecutors contains an agreement not to appeal any sentence of 41 months or less. Shavers will remain free on bail until his sentencing.

Bitcoin is a peer-to-peer payment system created in 2009 that is popular among certain groups due to its promises of security and anonymity. Shavers, known as Pirateat40 on popular Bitcoin Forum, began soliciting investors to park their Bitcoins ("BTC") in Bitcoin Savings and Trust ("BST"), a digital hedge fund that promised weekly returns of up to 7%. When asked how he was able to achieve such lucrative returns, Shavers told investors that he was involved in bitcoin arbitrage activity that included acting as a middleman for individuals who wished to purchase large quantities of BTC "off the radar.” Shavers later expanded on this explanation, saying

“If my business is illegal then anyone trading coins for cash and back to coins is doing something illegal. :)”

When further asked about his profit margins, Shavers indicated that he achieved gross returns of nearly 11% per week. As the operation progressed, the minimum investment amount was raised to 100 BTC, and investors were permitted to re-invest their profits.

The scheme began to crumble when Shavers announced that the weekly interest rate would decrease to 3.9% beginning August 1, 2012, and he allegedly began making preferential payouts to friends and longtime investors with his remaining funds. Later that month, Shavers declared default:

As much as I've tried to meet the deadlines within the community, there're conditions beyond my control which have escalated the process to the point it is today. Bitcoin Savings & Trust has hereby given notice of default to its account holders.

The decision was based on the general size and overall time required to manage the transactions. As the fund grew there were larger and larger coin movements which put strain on my reserve accounts and ultimately caused delays on withdraws and the inability to fund orders within my system. On the 14th I made a final attempt to relieve pressure off the system by reducing the rates I offered for deposits. In a perfect world this would allow me to hold more coins in reserve outside the system, but instead it only exponentially increased the amount of withdrawals overnight causing mass panic from many of my lenders.

However, according to authorities, Bitcoin Savings and Trust was nothing more than an elaborate scam that Shavers used to take in millions of dollars in BTC. In total, Shavers took in more than 700,000 BTC - which at one point constituted approximately seven percent of all Bitcoin then in public circulation. Through payments of purported interest, Shavers returned approximately 500,000 BTC to investors, and transferred the remainder - approximately 150,000 BTC then worth $1 million - to his personal account, which he used for a variety of unauthorized personal expenses, including rent and gambling. Shavers also attempted his hand at arbitrage, selling the BTC's for dollars and vice-versa, but suffered losses.

According to authorities, at least 48 of approximately 100 investors lost part or all of their investment with Shavers. Ironically, the Bitcoin raised by Shavers would have been worth over $150 million based on the current price of the commodity (the CFTC recently concluded that Bitcoin was a commodity).

Shavers was initially the subject of a civil enforcement action filed in July 2013 by the Securities and Exchange Commission. Shavers contested those charges, arguing that he was not subject to federal securities laws because Bitcoin could not be classified as a "security.” That argument was rejected and later affirmed by the District Court, which both found that Bitcoin investments satisfied the test espoused by the Supreme Court in S.E.C. v. W.J. Howey & Co., 328 U.S. 293 (1946) [subscribers can access an annotated version of this statute: | Lexis Advance]. Shavers was later criminally charged in November 2014.

The charges represented the first federal criminal securities fraud charges involving a Bitcoin-related scheme. 

 For more news and analysis of Ponzi schemes, visit Ponzitracker, a blog by Jordan Maglich, an attorney at Wiand Guerra King P.L.

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