What exactly does "flagging" files achieve? I have yet to see any effect.

Deleting or hiding these files from Bitzi is stupid and counter-productive. If people come across these files they won't know it's child pornography until they've downloaded and inspected it. Basically, you would be pretending child porn doesn't exist on public filesharing networks.

Further, the only harm done by downloading these files is that you're turning yourself into a criminal because possession of such content is illegal almost everywhere in the world.

What's more important is that distribution of such content is also illegal everywhere. It is obviously more likely that someone who distributes this content created it than someone who downloaded it. That means whenever someone is making such content available by sharing it, you can and should immediately report all available information to the police:

http://www.fbi.gov/innocent.htm

In fact, by listing such files in Bitzi, you make it much easier to discover and identify peers sharing such content. Yes, the downside is that is also easier to download these files, in theory. Again, little harm is done, especially no children are abused by this. It is much riskier for people to share these files if they are easy to identify as child porn. In the long run, that means these files will not be available at all, despite - or actually because - they are listed by Bitzi.

There could be done something regarding the filenames in Bitzi though. They should not be obfuscated but some of these sound like an advertisement and misleading names should be removed from identified child porn.

Maybe you also want to restrict searching and only allow lookups by SHA1, so that people cannot easily abuse Bitzi to search for the newest child porn although that would no very effective because there likely other ways to search for it, like searching directly on the filesharing networks.