It is as if that fiats aren't also a tool to be used by the these said criminal activities which in fact involves way more money than what it is in BTC or any other cryptocurrencies.
I agree with you on this point.
What should be done is to implement effective policies with regards to the use of cryptocurrencies rather than rejecting it completely because believe it or not, it would not minimize the criminal activities they are pertaining to.
Not sure I agree with you here. What kind of "policies" are you envisioning? Who is going to be implementing them? What punishments will there be?
Bitcoin is designed to be uncensorable. Unlike fiat, I can spend my money on anything I choose, without needing prior approval from a third party, and without risk of a third party shutting down my account or freezing my assets. Encroaching on that encroaches on the very nature of bitcoin. Centralized exchanges are already trying to turn themselves in to a police state, monitoring their users, blocking deposits and withdrawals to and from services they don't like, seizing assets and freezing accounts, and that's one of the reasons I would advocate that people stop using them. If you try to implement something similar on a protocol level, giving law enforcement agencies jurisdiction over
everybody's coins, then that would be the death of bitcoin as we know it.
We should be able to spend bitcoin on illegal goods, because if we can't, then it's because there is a third party stopping us from doing so and so bitcoin would no longer be peer-to-peer.
I don't think that Bitcoin being uncensorable would change with the the policies that I mentioned since it really is up to us on how much privacy we ought to share to others especially when we talk about Bitcoin and that, I think, is its beauty. The policies that I am saying is that there are solid ground to the laws with regards to fiats from their definition, extent and restriction that may not be applicable to Bitcoin or any other cryptocurrencies hence those who are caught red-handed may argue and escape the grasp of justice.
It is not a matter of controlling but rather setting a ground to what it really is.
On 7 March 2014, the Japanese government, in response to a series of questions asked in the National Diet, made a cabinet decision on the legal treatment of bitcoins in the form of answers to the questions. The decision did not see bitcoin as currency nor bond under the current Banking Act and Financial Instruments and Exchange Law, prohibiting banks and securities companies from dealing in bitcoins. The decision also acknowledges that there are no laws to unconditionally prohibit individuals or legal entities from receiving bitcoins in exchange for goods or services. Taxes may be applicable to bitcoins.
As of April 2017, cryptocurrency exchange businesses operating in Japan have been regulated by the Payment Services Act. Cryptocurrency exchange businesses have to be registered, keep records, take security measures, and take measures to protect customers. The law on cryptocurrency transactions must comply with the anti-money laundering law; and measures to protect users investors. The Payment Services Act defines “cryptocurrency” as a property value. The Act also states that cryptocurrency is limited to property values that are stored electronically on electronic devices, not a legal tender.
https://en.wikipedia.org/wiki/Legality_of_bitcoin_by_country_or_territoryAlso, by doing so, it could foster mass adoption with regards to Bitcoin with such legalization since people are more inclined to trust or rather willing to learn this new technology which are hindered mostly by their prejudices especially due to the media.
It is always up to you where to spend your bitcoins (like fiats) whether in spending it on legal and illegal goods or services but in doing so doesn't mean that you get away with the responsibilities on doing so.
It's technically cryptocurrency but are pegged to a fiat currency's value. 
