The "work for the dole" scheme required people in remote outback communities to work up to 25 hours a week to receive income benefits.
But its strict requirements meant that many vulnerable people were pushed further into poverty, critics said.
The government settled a lawsuit but did not admit it was at fault.
Several people had struggled to survive after having their payments cut off, advocates said.
Australia controversially requires welfare recipients to record job searches and other tasks in order to receive payments.
But advocates say these requirements disadvantage Aboriginal and Torres Strait Islander people living in some of Australia's poorest and most isolated communities.
Residents there have limited access to phone, internet and transport services. Many face additional language, cultural, education and health barriers.
Critics argued the Community Development Programme (CDP), introduced in 2015, was racist because it set harsher rules than other welfare schemes. Over 80% of those using the CDP were Aboriginal Australians.