LOD-
can be done while preserving uv information, there are real time methods used in maya 7(built in) as well as available as a plugin for earlier versions called Progressive Mesh
http://www.pojar.net/ProgressiveMesh/)
The source code is available
It's released under the The GNU Lesser General Public License.
http://www.pojar.net/ProgressiveMesh/ProgressiveMesh_V0_6_7.zipFull source code (To build the source code, you'll also need Michael Garland's QSlim source code and the boost libraries.)
http://graphics.cs.uiuc.edu/~garland/software/qslim.htmlhttp://www.boost.org/Theft -
People can steal textures from any source illegally, and the same goes for models. Perhaps a web-page publish database log should write some snap shots of your texture and or model (with a wetmark) to a page to allow for a content copyright method that dates your creation whenever a product is "finalized" or imported. If it is stolen from another source, anyone can look at the web-page and complain to the thief and enter a grief with that person and prove that they created it before or somewhere outside SL. This way SL can't be in anyway accountable(not that they could be anyway for that individuals theft - see Marvel vs NCSoft, where users were making Marvel characters with the open-ended tools available in-game and texture importing) SL should make sure that the amount of times something gets sold is kept tallied.
Physics -
If the Physics Engine Uses the Rigid Body Technique they could just use bounding box information or the simplied (lowest LOD) version for this purpose or stand-in-prims that could be associated with the shapes. Bounding Boxes would be most likely the most feasible and would require breaking your model down into smaller chunks, which is a good suggestion either way to keep the size and poly counts down(as fore-mentioned).
-Capitalism
Personally, If there was an engine that could allow many people to be online together in an environment, with the scripting particle and animation abilities that SL has only that would allow custom geometry and characters using any modelling program I would be in heaven, and would switch over to that program in a heartbeat. It would then be as though you were able to really make your own content for an open-ended game engine that all can play. The hassle of modelling with the prim engine, is really the biggest downfall in my opinion. It is way too slow of a process and limiting. I don't have the time to go about modelling in this archaic method. I could make so many cool things in very little time if only you would untie my hands. Limiting the amount of polys that can be imported will force people to get very good at efficient low res modeling. The idea of capitalism is that, people with better skills to make the best products should be allowed to make more money, not the people with the most time.
-Lag
I think it would be possible to limit the number of polys that are imported. I think the allowable amount to be imported should correspond with the prims. You have to own the land or be given permission by a land owner to upload meshes into a sim, and it needs to stay on that grid, if it is part of an environment, and takes away from the total poly/prim total that can be created on that land to keep the interaction clean. . If it is part of a character or for a vehicle then there should be a set amount each person can use, that they can take with them anywhere, and have ownership to.
You should limit the amount a character can wear or "rez" at any given time, and limit the number of people that can be on a grid(if this isn't already done) Lag can be controlled very specifically.
-Facial Animation/Shapes
I would really like to see facial morph shapes, or at least animatable facial textures, at least. So much of communication relies on the face, and we rely on our avatars to convey our emotions, not just our words. A very easy to use gui for making facial animation in SL is needed.
-Normal Mapping Support
If SL is going to spend that 3million$USon something. Consider putting it towards this. Ideally, an engine that supported real-time normal mapping would make for a huge jump in the amount of detail that could appear on lower res geometry. You could even have an option to automate this. Create a standalone program used oustide SL that can use a hires geometry and its simplified version and create a normal map, if packages like zbrush or maya aren't accessible. It's not that hard.