Item binding is the most widely-known way of preventing players from trading items, but not the only one; people tend to overlook the simpler expedient of making items impossible to list in the auction house or trade directly to another player. The best reason for ensuring that items can only be used by a single player is to prevent players from cheating themselves or each other out of gameplay. Pet breeding is my favorite example; if you want players to have fun spending time capturing and breeding pets, you need to make sure the market isn't flooded with bred pets being sold more cheaply than the player could breed their own. With gear, the idea is that if the gear were salable then it would remove the motive for players to run dungeons, especially beyond the first run. In a system where dungeons don't scale to 1 or 2 player groups but instead require at least a full trinity of tank-healer-dps, everyone would have more difficulty getting a group to run a dungeon with them if there weren't a whole set of unique gear dropped by the boss. Other types of drops, like mounts or vanity pets can also be bind-on-pickup drops that provide this kind of motivation, or the unique drop could instead be an expensive crafting mate that was used to craft the desired gear, but gear tiers work as a pacing device if the set of gear from one dungeon or region is actually necessary to survive the next dungeon or region. If you need a whole dungeon party with most or all of the first gear set in order to survive the second dungeon/region, that's a fairly strong encouragement for a group to repeatedly run the first dungeon/region until everyone gets some gear. And the economics of MMO design are largely about getting players to spend the most time on the least content, which results in players spending money on either subscriptions or cash shop currency with which to speed themselves up one way or another.

This leads me in a follow up question I got when thinking about a unique item drop mechanic, where an item has a low drop chance and only drops once. Should an item like that be soulbound and making it impossible for other any other player to get it, or should it be in your opinion, a tradeable item, resulting in a high auction price, if the player decides to sell it?
Thanks.

Personally I dislike random rare drops; I favor fixed drops like, the 10th time a particular avatar participates in killing a particular boss, that avatar gets the boss's rare drop. If 2 or 3 characters are all on their 10th time, they all get one. But whether that drop should be salable totally depends on your game structure, as I was mentioning in your previous post. Is your game a trinity-based themepark where you want all players to spend the majority of their time repeatedly running dungeons?

Unique items are something I don't use at all in my designs, because I think they are pointless, but if you're going to have them I don't see any reason to make them non-salable. In fact auctions of a particularly rare item like that can turn into interesting community events.

Honestly, I think the smartest thing to do is make most items soulbound on drop, and have cash shop items (fairly cheap) that remove this restriction. I've seen that pretty commonly with recent games.

Then you might end up with an auction house that's empty of lower level items.

I think it's mostly to do with encouraging players to play certain content themselves and for making it harder to buy power. In a game where items are bound to the character when they drop, then you know that if you see someone wearing that item, they're at least competent enough to have run the dungeon where that item drops. Higher level dungeons tend to be more complicated as well as requiring better armor/weapons, so you really want players to learn from the lower level ones before they attempt the harder ones. It's not fun for anyone when a noob buys top tier equipment and joins an advanced group without understanding how to play the character.

Personally, I think a mix of bind on pickup and tradeable drops makes the most sense. Bind on pickup drops are important for encouraging players to progress through content in the right order, but if everything is bind on pickup then well geared players lose their incentive to run lower tier content. Whatever stage of the game you're in, there's typically only a few instances that are worth running at any given time because the others are either too difficult or the drops are worse than what you already have. (It's boring if you're stuck repeating only the same dungeon for a long time with no variety, and it's a waste of content if you advance past dungeons without playing them much if at all.)

The principle I'd suggest is that at any stage of gear progression, the player should be able to spend game money to improve their power level, (such as using valuable tradeable consumables or adding tradeable gems to BoP armor) however without getting bind on pickup gear a player should still be less powerful than an equivalent player that does run those instances. One could also argue for limiting tradeable drops to cosmetic items and other items that aren't combat related, but without items that are useful in relation to the game's primary mechanic (which is usually combat, although in some MMOs it could apply to some sort of crafting skill as well) a lot of players won't care - tradeable items need to be useful for players to actually want to buy or farm for them.