Yup, all they could do is outlaw the exchange of BTC to fiat currencies. That isn't such a bad thing if you think about it. Yes it puts an end to the exchange rate speculators on MtGox but so what? You would no longer have a real reference to the USD or other fiat currencies. So what?
We need to get away from thinking in terms of "Oh boy I have $2000 worth of BTC! I can't wait to convert it to USD and spend it on something!" The path ahead for BTC is for it to have its value anchored in real goods and services.
Exchanging it with USD is just a crutch and keeps BTC mired in the realm of conspiracy theories and other kookiness.
Decentralization of exchanges will make it effectively impossible to prevent exchange into anything…no bank accounts even necessary. But, government could declare it illegal to exchange it for good or services, fiat included. That would mean that only people and businesses willing to ignore such a law would continue to deal with Bitcoin. But such a move would would ultimately weaken government. Hence I doubt outright banning of Bitcoin is the path they will take. They will try to marginalize it or even co-opt it through various means (regulations, four horsemen, embrace and extend, etc).
I also believe that Bitcoin is protected by the free speech provisions in the US constitution's 1st amendment. So, while laws could be passed, the US government's own constitution makes such laws invalid. And, regardless of any law or constitution on this planet, no person has any right to deem Bitcoin, or the use of it in trade, illegal or to persecute those that voluntarily choose to use it.
Hmmmm... unfortunately, the US government doesn't really give a flying rat's ass about the 1st Amendment. Not only is there a Patriot Act, but there's also a Patriot Act II, which effectively makes it illegal to discuss any cases under the Patriot Act.
Also, while the bitcoin community might be a bit "US-heavy", the US is but one government that might be tempted to do something about this. I, for one, am a lot more interested in what approach the Chinese government will take.
Government regulation isn't a make-or-break situation for Bitcoin, as it can't be broken that way. But it certainly is a make-or-not make kind of situation, if you know what I mean. All it would take would be for China to express the slightest of interests in using Bitcoin as a hedge, and we're off to the races!
