We haven't seen any evidence yet that dragons and the five races can have children. That's all speculation based on Yugiri and the enemies in SV and Snowcloak.
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Didn't one of the GMs at the fan festival say that it's entirely possible for the 5 races to have children with each other?
It's been stated in several places that the five races can in fact interbreed. At Fanfest for example someone asked if a Roe (male) and lalafell (female) could produce a child and the answer was basically that it's possibly but don't ask them how it happens.
That and hybrids were listed as a potential racial option, meaning that it kind of has to be plausible. It's not like there is going to be a random lore explanation for it happening, or I certainly hope there wouldn't be.
I got the impression that some knew him by face, though that may have been in the context of having seen the impostor earlier-but-after-he-started. In any case, he seemed very high profile. It's kind of absurd to go in assuming that there wouldn't be anyone who could say, "Nope, your face is wrong!" Not when you have access to appearance changing magics.
There was also the corpse of the real inquisitor. I'm kicking myself for not checking closer, but I thought he looked the same.
This was the case in FFXI, as well - until they suddenly changed their mind and added a hume/elvaan hybrid for the Wings of the Goddess expansion. The only hybrid seen before or since. If they think it will make a good story, or think there's a big demand for it, hybrids will become possible.
As for the dolphins vs dragons bestiality debate, it really comes down to how you define bestiality. To me, beastiality is bad because you're essentially using an animal as a masturbatory tool. The actual "evilness" of this is debatable, presuming the animal isn't harmed by it, but society in general frowns on it. The idea, though, is that you should be engaging in sex only with a willing, consenting partner.
Can a dolphin give willing consent? I don't know. Our ability to communicate with dolphins is extraordinarily limited, regardless of their intelligence. If dolphins are really as intelligent as humans, or as close to it as some claim, their intelligence is too alien to us for a human/dolphin pairing to form a meaningful romantic relationship. BUT, if such a mutual relationship could be formed then, heck no, I wouldn't consider it beastiality.
Dragons in FFXIV, on the other hand, are shown to have very humanlike intelligence. They engage in wars much like humans, they dabble in subterfuge, they carry grudges and plot revenge, and they communicate easily with humans using human language, implying that they share many if not all of the concepts that humans do. As was mentioned in the thread, dragons are, essentially, a bit more beastly beastmen, and beastmen are basically humans that have beastlike traits. While we haven't seen any of the GOOD human traits in dragons (traits that would pretty much be necessary for a true romance to be possible), we've pretty much been exposed to nothing but their hostile side up to this point. Shiva, Iceblood, and the heretics seem to be implying that those traits do exist in dragons.
If two intelligent beings and form a mutual consenting bond, then no, I wouldn't consider it beastiality, regardless of the species involved. This kind of thing is the bread and butter of sci-fi involving alien races, and I've long ago come to terms with it.
And, due to dragons' purported transformative powers, even the physical differences don't have to be an issue. While they call it "glamour", implying an illusion rather than an actual transformation, this so-called "illusion" is powerful enough that hulking dragons can easily mingle with humans in their human-sized homes without knocking people down with their invisible wings or crushing furnature with their invisible tails. I'd say that glamour transformations go well-beyond actual illusions. Similar cases can be found in certain transformed Sylphs (who I will not name for spoiler reasons) who transform into humans and interact with them with no one the wiser.
I'm somewhat skeptical of the idea that the pc races can interbreed. During Hildibrand questline about the maiden of Costa Rica, the reporter lady points out that the maiden, being a Hyur, is clearly not a biological daughter of the father, a lalafell.
I think the exact term she used was 'it's obvious you are not biological child of X'.