Why do governments have such difficulty regulating Bitcoin and other cryptocurrencies?

The challenge for government regulatory bodies to issue “enforceable” regulation over crypto is it needs to cover 3 main areas, which are very difficult to cover without overlapping or infringing into each other -- these are privacy, security, and fraud.

For example, in order to prevent fraud, the government needs to know more about the parties involved in the transaction so they can issue regulations to allow them to persecute an individual. If they issue a regulation to reduce/protect consumers against fraud, then your privacy will get compromised - because you will stop being anonymous and therefore less secure.

On the other hand, if you want to be able to disclose some information to X but not Y, then the current security layer in place is not adequate. If you modify the current security layer in the current blockchain implementations, it could become very cumbersome for the average user to manage and/or it will require some level of centralization which goes against the idea of a fully decentralized model.

The big challenge for the regulators is how to apply governance and user protection rules to a new system without interfering with its design in such a way that it will change it into another system alltogether. For bitcoin and other cryptocurrencies to be widely accepted, some measures will need to be in place to identify and remove bad actors.

Think about it, next time your wallet (or your grandma's crypto wallet) gets hacked and a small fortune in tokens gets removed from your vault, wouldn't you like to be able to go to the “police” and have the police track the bad guys, arrest them and get your money back? I surely and I am pretty sure my grandma does too!

Unfortunately today no such mechanism is in place… for me, today is still a bit like the wild west, to recover your gold, you kinda have to go out and hire some skilled gunslingers (aka hacker/mercenaries) to trace the bad guys and bring you back your vault with your gold in it :-)  

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