There definitely needs to be a separation between aesthetics and function in gear. Players should for the most part be allowed to look how they want to and function how they want to simultaneously. Whether you make aesthetics completely open, or make them as difficult to earn as functions-- either way is better than limiting players to choosing one or the other (because then it's really not much of a choice).
I agree with 98% of your post but on this I would like to point out that the rewards don't have to be better gear or even gear at all. Relative back to the transition from lvl progression to skill progression. Skill sets, abilities, enhancements, spells all sorts of things can be rewarded upon advancement.
I'm glad you pointed this out. In FFXI and nearly every MMO, you kill things for two reasons: xp or stuff (money/equipment). XP is a very general kind of character enhancement though, and there are many more ways that can add depth and complexity to the system. For example, the way BLU learned skills from enemies. Some games give you bonuses for your title. I'd like to see more quested abilities and character progression in general, rather than "get enough generic XP and you can access it."
There just isn't much flavor to the enhancement in most MMOs. You grind xp to progress your character, and then you grind bosses to improve your gear. Personally I wouldn't mind seeing small permabonuses for achievements. Fafnir may not have something you need, but killing him once will give you an epic HP bonus (epic in name only). Why not bosses you have to defeat to learn certain spells or abilities? Some relatively novel originality.
I give the benefit of the doubt that SE would have done these sorts of things in XI if they weren't so limited before by hardware and experience, or at least I'd like to, but seeing how they allocated their developmental resources in XI doesn't instill me with purest hopefulness.
Ok, now we're going to get slash fiction of Wint x Kachi somehere... rule 34 and all...
Never confuse your inference as the listener for an implication of the speaker.
Good games are subjective like good food is subjective. You're not going to seriously tell me that there's not a psychological basis for why pizza is great and lutefisk is revolting. The thing about subjectivity is that, as subjects go, humans actually have a great deal in common.