Now we are talking and by giving those facts out, I think it makes somewhat sense to delay at the server. However, if precise consistency is required I believe that delay at the clients based on timestamp is also necessary when packet is received because the second part of the rtt is still unknown. (so every client sees everything in sync). Ofc. clients already has the data so it could be possible to "hack it visible". But those are just tradeoffs which needs to be made.
If the delay is continuously adjusted during the game, such a player could do nasty things. Join the game at a natural rate, then turn on a tool like clumsy on their own machine for outbound communication, and suddenly the responsive game becomes very unresponsive for all players. With a bit of care that kind of subtle annoying attack could look like regular Internet noise, a claim "someone else turned on Netflix" could cause problems.
And yes, you are right. this is quite possible - thats why specifying fixed local lag value not based on estimate on players ping could be more wiser. And that local lag value needs to be measured based on the aspects of individual games. (how much it can tolerate).
I will try to draw it out in sequence diagram and see how it could work.
But, even then at least when using CS architecture - I assume that local lag alone as a compensatory technique is not enough and some prediction or hints for players are also needed... e.g. playing animation at the client/sounds when replies are still hanging at the server. etc.
Valves Source engine / Counter Strike, which is about the most popular client-server PC FPS game, implements this. There's a full description of their algorithm on their wiki somewhere (sorry I don't have the link handy).
IIRC, every client is running about 100ms in the past, even if their ping is <100ms. The server constantly rewinds and fast-forwards the game-state to insert client triggered events at the right points in time.
I think Battlefield implements it too, but they've not publicly described their algorithm.
Hodgman, thnx for the tip.. But I have read their wiki and I cant find anything like that... are you sure you are not mixing that for interpolation? they has interp value of 100ms and the server uses lag compensation to "replay" events at the server as they were happening -100ms ago - so bullets can be placed to targets and so on.. Local lag is different because it increases the latency of your key presses to give messages enough time to reach the other participants.