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Does Government Regulation Destroy the Bitcoin Model?

The government likes to give a hard time to alternative currencies.
Back in the day, the government tried to destroy egold by going after the 'digital money exchangers'. These folks were unlicensed and the government would seize assets and levy fines.
(1) What would prevent the government from going after the digital money exchangers of bitcoin using fines, licensing, and /or sales tax?

AND.. Suppose they regulate bitcoin and jail the first generation of digital money exchangers.
(2) Does this affect the Bitcoin alternative currency model at all?

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My strategy

My strategy is to speculate. I will assume that the government will move to tax bitcoin if it gets too large. I assume that I missed the exponental growth of money but I should have time to double my speculation. So I will buy and sell after a doubling.

When Mt. Gox got involved

When Mt. Gox got involved with Silicon Valley Bank, they are now forced to follow all of the normal Banking laws. A new law passed requires all Exchanges to follow similar laws; anonymity is nearly gone for the vast majority of BitCoin users. Mt. Gox is the largest exchange, therefore it gets the most customers, which are now tracked and monitored. The only way to acquire BitCoin without having to use some form of ID is to buy them from individuals or to sell things for BitCoin. This will require someone to actually buy the BitCoin from the Exchanges or to mine the BitCoins themselves.

The method of validation used to verify each BitCoin can also be used as a form of tracking if a BitCoin ever gets confiscated by Government; because the BitCoin maintains a record of its history to ensure that it is valid.

Also, while BitCoin proponents say that BitCoin has a limit of 21 million BitCoins; this is semi-false; because I could trade an infinitesimally small fraction of a BitCoin; meaning that while the number of whole BitCoins can never go above 21 million, people would be trading an infinite number of fractions of BitCoins, thereby making the currency infinite in quantity.

This is a function current Banks have but people do not in our current currencies throughout the world. A Bank can utilize $0.000001 while people can only utilize $0.01. This limited number of fractions of dollars -meaning a dollar can only be broken down into 100 cents is what typically keeps value for the dollar; however, printing an unlimited number of dollars dissolves this function. BitCoin has no lower limit, meaning that one day people could be trading 1X10^-100 and the next they could be trading 1X10^-1000000; it is the same thing as meaningless or as an unlimited quantity of paper currency. How valuable would a dollar be when there exists in the world 1X10^100000 dollars; that is how valuable BitCoin would be when people start trading using 1X10^-1000000 BitCoin.

They can DO whatever they want

That's obvious. But for others with real wealth stored in bitcoin, it will just drive the innovation of the underground market harder.

Take a look at TOR. It will let any communication take place cryptographically secure, even from the NSA snooping. What is to stop Bitcoin transactions (and the communications surrounding that transaction) from just being encrypted away from the sight of the government?

This increased security may not help Bitcoin in the new car sales market, but other non-regulated items can certainly be brought into an underground, black market model. I'm not really thinking they would want to drive 80% of our economy underground. LOL