With the technical challenges more or less resolved, I think the biggest challenge for LBS is user acceptance owing to privacy and security issues.
Location based services face distrust by users owing to the loss of personal freedom and control over the technology e.g. intrusive advertising, commercial pressure, loss of autonomy, etc. It is crucial for the service provider to maintain a level of trust with users by acting transparently with regards to personal privacy translating into strict application of a code of ethics on the service use combined with clear and simple information for consumers on the usages that could be made of their location data/ensure consumers have the means of controlling what they can and cannot do i.e. right not to be located, not to be disconnected, choose who will have access to his data, etc.
RoseIndia tackles the privacy and security issues in detail
Ajit Jaokar gives his take on solving the privacy issues in his post Could the 5o9inc approach be a solution to the privacy problem for location based services?