1) Monsters (and perhaps animals) are grouped into levels based on overall power.
2) To become a monster, a player can choose to reincarnate as a first level monster instead of ressurecting. This saves from having to program a whole new character creation prossess for the client. Monsters cannot reincarnate as humans.
3) Monsters gain experience from fighting. Monsters do not gain stat or skill increases. A certain amount of experience is required for a monster to reincarnate as a monster of the next level. The experience required rises at an exponential rate for each successive level. A monster can also choose to reincarnate as a monster of the same type, unless they are of the highest level, in which case they are forced to reincarnate as first level monsters. Monsters cannot reincarnate instantly. Instead, like when someone ressurects on the spot one too many times, they must wait an arbitrary period of time before reincarnating.
4) Monsters spawn in dungeon levels or in particular areas on the surface based on level and type of monster. Dungeon monsters cannot travel outside the dungeon they spawn in, or perhaps even the dungeon level. Seers should be able to transport any monster if necessary for participation in a quest. I haven't decided if any movement restrictions are needed for surface monsters, but they should be "kill on sight" to guards.
5) NO monster may pick up, drop or equip items. Monsters are awarded loot based on type and experience as a reward for any humans who kill them. Magic weilding monsters can call up the spellbook gump to cast certain preset spells according to monster type.
6) Only monsters of the same type can understand each other. Sufficiently intelligent or skilled humans can understand certain monsters, based on which languages the human chooses to study.
Remember, I cannot take full credit for these ideas. Many of them are from Runesaber and other contributors mentioned in his post. Comments and constructive criticism are welcome.
Addenda:
Forgot to add monster caps (if there are too many of a particular monster on a shard) and access to paperdoll options such as logout (doh!)
After much thought, I have been swayed to the camp which supports monster development. I see it implimented in this manner: Monsters can advance stats ONLY. For each new monster type a player reincarnates as, their stats are set significantly below current NPC monster stats for that type and are allowed to work their way up to moderately above current NPC monster stats for that type. My initial reasons for being against this was a fear that player monsters would be dominated by overly powerful monsters, similar to how players are dominated by overly wealthy and powerful players now.