If the leveling down fit in the story it would work.
Taking the huge blight example, you need to sacrifice some of your power so the citizens you just freed can defend themselves while you are gone to liberate the next town, that could work. Or maybe mortally wounded through each battle (like DA:O only without being able to cure them). But I just don't see it working as an MMO, action adventure (someone above mentioned Devil May Cry and that would work) would seem to be a better fit only because you wouldn't accidently loose extra levels and not punish exploration.
Taking the huge blight example, you need to sacrifice some of your power so the citizens you just freed can defend themselves while you are gone to liberate the next town, that could work. Or maybe mortally wounded through each battle (like DA:O only without being able to cure them). But I just don't see it working as an MMO, action adventure (someone above mentioned Devil May Cry and that would work) would seem to be a better fit only because you wouldn't accidently loose extra levels and not punish exploration.