I knew about Bitcoin quite early, but I was convinced the government would shut it down. I am mystified as to why they didn't.

Possibly because it's not actually as anonymous as some people believe.

Some governments have banned it, many haven't. It's likely that Bitcoin (and cryptocurrencies in general) aren't, and never were, the existential threat to governments as a whole that anarcho-capitalists wanted it it to be.

States and law enforcement are more likely to be concerned with what Bitcoin is used for, than the mere fact that it is used.

The government can't just "shut down" whatever it wants in a society like the US with (relatively) strong rule of law.

They cannot--coordinating enforcement is impossible for nation state actors, at least not yet.

Shutting it completely down is impossible, but making possession illegal is not.

Same here. In the early days, the price was driven by emotion. Every time there was a problem, everyone sold and the price went to the floor.