"They don't, but that's because Euros/Yens are backed by foreign governments".
No, that is not the reason. Replace "Euros/Yens" with "gold" in my sentence, and my point stands with gold being backed by nothing. Basically the US government is totally fine with side markets that they cannot control directly and that exist in parallel with the USD (whether it is EUR, gold, Bitcoin, whatever).
Your other argument also fails to convince me that the government would want to declare Bitcoin illegal. You say it can be used for money laundering, but gold and cash can already be used for money laundering (and even more discreetly since trading gold or cash does not leave a trail like in the Bitcoin blockchain). The US govt does not make gold and cash illegal because they realize it is silly/unenforcable/pointless and would hurt the economy more than it would manage reducing illegal activity. Case in point: the US did attempt to criminalize possession of gold in 1933, but they eventually realized how silly and stupid this was, so they decriminalized it!
When the Internet was being developed throughout the world, were you the kind of person who looked at it and envisioned that its censorship-resistant decentralized aspect could be used to facilitate the transmission of potentially illegal information (software, data, child porn, ideas, etc, especially in countries with no freedom of speech) and said "geesh I bet governments are going to make Internet illegal"?
"For one, the government doesn't care for 'startups springing up everywhere'"
I think my point was clear that these startups are potentially the start of a big new economy complementing the current one that could financially benefit the government with revenues from taxes. So, yes, the government would love to see a big economy pop up.
"Plus, if bitcoin is banned, its economic activity will just migrate to conventional money again, it wont be lost."
No. The world economy is not a zero-sum game. It is possible to create wealth (wealth is stuff we want, not money, see http://www.paulgraham.com/wealth.html ) and Bitcoin and its economy would certainly create extra wealth. Another example showing how silly your assumption that the economy is a zero-sum game is: since the start of e-commerce, do you think that it has stolen commerce from or mostly added to the brick-and-mortar industry? Obviously, sometimes stolen (journals, etc) but e-commerce has mostly added wealth and economic activity on top of the brick-and-mortar one. In other word the size and richness and wealth of the current economy far surpases the one of the economy pre-Internet.
