It's already a couple of months that I'm planning to write a comprehensive post about rewards in MMORPGs. But the more I think of it, the more I discover links to related subjects like player motivation and incentive structures, and it is hard to really cover the whole of the subject. So now I spent some time to boil all those ideas down to something which gives a good overview of the function of rewards and the different possible reward systems, but is limited to my core ideas, without becoming a complete dissertation.
Playing a MMORPG provides the player with many different forms of rewards: Intangible ones like fun or social contacts, and tangible (in the virtual world) ones like various points, currencies, and items. In this post I will concentrate on items, especially "epics", but I'll include the special tokens ("emblems") that are given out as an alternative way to get epics. As I'll mostly use examples from World of Warcraft, concentrating on epics means I'm basically skipping the whole leveling game, and go straight to the endgame. The reason I am doing that is that I found that rewards aren't necessarily the driving factor for what people do while leveling up: Much of the leveling up game is non-repetitive, and has strong elements of exploration and discovery of new zones and stories. Just like a book doesn't need to hand out rewards to encourage you to read it, the entertainment value of the leveling game is often high enough so that the rewards aren't really all that important. In the specific case of Wrath of the Lich King, on leveling from 70 to 80 by doing quests, you will vendor around 99% of your quest rewards.
Once you reach the endgame, the level cap, the entertainment value of playing a MMORPG diminishes, because it becomes more repetitive. Even Blizzard, with their $1 billion revenue per year, cannot produce enough non-repetitive content to keep most players busy enough. So instead of seeing new zones and hearing new stories, in the endgame you do the same daily quests, the same heroic dungeons, the same raid dungeons over and over. Wrath of the Lich King is not even two months old, and already more than half of the players online are level 80, and busy with this sort of endgame content. Being repetitive extends the lifetime of a MMORPG, but diminishes the entertainment value. So the less players are driven by the motivation to see new content, the more you need to motivate them by something else: Rewards. And in World of Warcraft the typical form of an endgame item reward is called an "epic", recognizable by the purple name, but otherwise not fundamentally different from non-epic gear rewards. The main function of epics is to make your character stronger, but there is a secondary purpose of bragging rights, related to the difficulty of acquiring those epics.
Now rewards in general can be handed out in different ways: You can give somebody a steady stream of minor rewards, or you can give somebody the occasional big reward. In WoW 1.0 epics were nearly exclusively of the occasional big reward variety. You went raiding with 40 people, among whom on a typical raid night only a handful of epic items was distributed. With a bit of bad luck it could be weeks before you got your next reward. Not everyone likes that sort of system. But the random big reward system has certain advantages: An occasional big reward produces a stronger emotional response in the player than a steady stream of small rewards (which is why people buy lottery tickets). And the random loot drop system for epics is self-regulating: The more epics you already have, the smaller is the chance of still finding an upgrade. Character development is asymptotic, that is your character will always only get stronger, but the rate in which he grows steadily decreases until it is zero. At one point, hypothetical for most players, you have the best possible equipment in the game and can't get any more rewards.
Of course the random big reward system also has disadvantages: You can be plagued by bad luck and not receive any reward for a long time, and as the diminishing returns are built into the system, the motivation from rewards also diminishes with time. So with patches and expansions World of Warcraft started to mix some steady small rewards into their reward system. First you could get PvP epics through patient accumulation of honor points. Then you could get epics through exalted reputations, or through crafting, both of which required a lot of grinding. And finally a system of "badges" or "emblems" was introduced, so that every heroic or raid boss kill was worth at least one of these tokens, and you'd need to collect a number of them to buy epics with. A special currency, just for slowly but steadily gaining epics.
Giving out rewards at a steady rate solves the problem of bad luck, but doesn't solve the problem of there being a point in time where no further improvement is possible. Blizzard can only push that point in time further into the future by adding new raid content including new sets of gear to collect. But what they also did was to allow to divert rewards from the character who acquired them to another avatar of the same player, by introducing hereditary items. You can now spend your emblems on gearing up your alts to not-quite-epic "good blue" level. Which on the one side sadly removes the item gathering part of gameplay from your alts, but on the other side solves the problem of having to go to dungeons for gear and not being able to find a group.
So the current system in World of Warcraft is a mix between different systems to hand out loot. It still isn't perfect, but it is a good compromise. You will get *something* on every successful raid, some emblems which you can accumulate and use to fix holes in your equipment, or gear up your alts if your main already has everything. But you also have a chance to get the occasional random lucky loot drop, for a quick shot of happiness. The overall purpose is to get you to play the same content over and over, to extend the game's lifetime, or rather your subscription time. That is proven to work to some extent with most people. How long it can work, and whether it will work less and less with each expansion, remains to be seen. But up to now, rewards are one of the strongest incentives to keep people playing MMORPGs for years and years. It is easy to criticize people for "running after purple pixels", but nobody has invented a better system of incentives yet.