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What is "many"?
More than 8, apparently.
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B) "able to interact {in ways beyond talking to eachother}"
Add 'simultaneously' in and you'll get the point.
Diablo II may 'technically' be an MMO, using your 'list of characteristics.'
However, using common language and conotation, Diablo II is not an MMO. You could say that any game that has many players playing online and interacting with each other, even if in distinct areas (eight player games) is an MMO, but you'd be correct only technically. In common colloquial and general understanding, an MMO is defined in such a way that Diablo II is excluded.
In any case, it should be obvious that the OP was talking about MMO's in which there are possibly more than eight players about at the same time and the issues with having realtime combat on that scale. Somehow, I don't think that Diablo II would run into the set of hurdles the OP describes, being that it doesn't have more than eight simultaneous players per game instance.
So, in conclusion, Diablo II is technically an MMO though in reality not, and whether Diablo II is an MMO is irrelevant because it invariably does not run into the problems the OP is talking about.
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OdHero, I've been exploring the same thing. The simple 'autoattack' button is really a bandwidth saver - any gameplay bonuses are purely incidental. This asside, look at games like Tony Hawk's Underground 2 and Agressive Inline. Ironically, these games have some of the best character advancement system's I've seen. It's not just about time invested in slaying enemies - it's about your abilities. In THUG2, your character's stats are increased once you perform certain tricks or combos. Essentially, there are boundaries that you cannot cross, regardless of time invested, unless you have the skills required to do so. In agressive inline, your abilities improve as you perform tricks more often. I think that a combination of the two systems would provide the optimal balance in any MMO (assuming you're talking about RPG's) - especially those with real time battle. Your strength improves when you use it, you get rewarded for accomlishing feats. This system vaguely reminds me of . . . reality. You do get stronger by using your muscles and you are rewarded for accomplishments (well, accomplishments are rewards). In any case, rewarding players for something more than just time played would be the key to a realtime MMO. In fact, rewarding players for time played is really just a ploy to get players to play longer and pay more monthly subscription fees. Every other game is intrinsically rewarding - MMO's are the only ones that reward you just for time.
Reward players for doing things that are fun and you'll have the right balance. Then you can get started on the real issues to deal with - like cost and bandwidth.