Why might governments choose to officially recognize cryptocurrencies like Bitcoin?

The above quote can perhaps best describe what Bitcoin is to the governments worldwide. Its a tangential form of blasphemy.

Most bankers that I have talked to, in various countries are skeptical of Bitcoin and honestly don't understand it. Some cite it as being a mere joke, whilst others have a difficult time in understanding the technical and economical merits of the Bitcoin ecosystem. It seems everyone is is agreeable on one thing, they don't want to immediately issue too harsh of a statement against it, best to give a reserved judgment and see how it goes. Such reserved judgments have been in the form to discourage any institutional money being channeled to the crypto-currency domain forest.

It becomes very difficult for regulators to allow legal coverage to crypto-currencies in their existing closed-loop fiat currency models. As a protocol, one that is purely serves as a transactional ledger, there is not much to debate on, the protocol is rock solid and has a place in the monetary system. However, when we talk about Bitcoin has a form of money, i.e. currency, then it poses problems.

If you approve one currency, then how do you stop other currencies? Surely, the regulators cannot just give a freehand to the crypto-currencies?

Taxation, money supply control and risk mitigation is the core (in my opinion) for any regulator. With the induction of bitcoins into a regular economy, there are too many tentacles that the regulator cannot control, and herein lies the problem.

It can be said with a lot of certainty, that the only element that the governments can really control is the connection of the crypto-currency with the fiat currency. Regulate that and you essentially cut off the oxygen supply.

The downside to such an approach is that you have two factors working against you:

1. The fact that anywhere there is a TCP/IP connection can be a trading node for these crypto-currencies
2. The fact that underground (read: non-approved) market makers will flourish all over the place making the on/off-loading process to the crypto-currency platforms on/off to the fiat currency, will suddenly blossom and mushroom.

It seems every government is looking at the other. To see what they would be doing. US for example is a strong candidate to watch (particularly how NY's DFS - Department of Financial Services) lays out the ground-rules for Bitcoin, et. al. China and India in my opinion are the other two important markets.

Even the definition of private money is just a temporary patch. The ruleset and guidelines (again in my opinion) that are required to integrate Bitcoin into our regular fiat currency systems are not ready or even drafted to the point where regulators are truly satisfied. I believe a couple of iterative processes will eventually bring us to that stage.

Every Economist that I have talked to, knows and admits privately that the current monetary system is way out of whack. Its broken and so screwed up, to the point that it will suffer one huge implosion. The financial crises of 2008 would just become more cyclical and frequent. The shape that the financial crises would take, would be different each time, but rest assured, the problems posed by fractional reserve banking and the economic models we are following right now, are increasing the national debts in each and every country. There seems to be no solution to this. Bitcoin in itself is also not a solution to this problem, but what governments do fear that their currencies can lose value extremely fast, should their real-world currencies/economies start failing and people transport their trust to the crypto-currency system. This is a very real fear and because of this, immediate recognition of Bitcoin equal to that of their own fiat currency would not occur any time soon. It might eventually, but not immediately.

Right now, the only view from the tunneled vision of the regulators is taxation and somehow regulation of the crypto-currency.

Governments that want to rid themselves of their traditional currency and economic models, can opt to go for a sovereign default and then dismantle years and years of seemingly solid economic models and make Bitcoin (or equivalent) currency as their de facto currency. Now that would be truly adopting the currency, but it poses major challenges. The inertia to have such an idea come true is enormous.

As the great Bernard Shaw said, I think we are still in the disbelief stage where we are terming the crypto-currencies as blasphemy in the traditional economic and banking terms.