How is character animation done. Do we have to load each position of the character into memory, or do we move the object on the fly?

Either way.

I know that in Quake, the whole characters mesh is stored in a bunch of different positions. Each position is called a keyframe. For each Quake character the whole mesh is stored 198 times in different positions. When you render the character, you have to interpolate between the triangles in two different meshes. I think EQ does it this way also.

The other way, which I''m not too familiar with, is to move just parts, but you have lots of problems with cracking in the mesh at joints and things. This is much less memory intensive, but its more cpu intensive. The advantage of this approach is that you can combine several movements at once. For instance, your character can be running and get shot in the shoulder - and merge both animations into one. I think AO uses this scheme.