Here are my suggestions...
No loot should be lost from losing a duel, however bets could be made if aggreed upon. (This would be an implemented part of the game otherwise scams could occur).
Both duelists would see the other persons duelling rank(yes, i just made that up, but it would be good to have one) and class, then they both say howmuch they wish to bet on the duel, with 0g being one of the choices.
The actual bet amount is the lowest bet from either person. Lets say player1 bet 50g that he would win, and player2 bet 5k that he would win, both players would then bet 50g (as it is the lower of the 2 bets) and the winner takes home 100g (his own 50g and his opponants 50g).
You would be able to challenge anyone to a duel, as long as the person you are challenging has the "Duel" option ticked, this would be found in the friends list, much like the status options (e.g. you can be away, busy, offline, online, now you will have a box next to that one giving you an option of duelling on or off).
If your duelling is set to on, then at anytime in a town you can be challanged to a duel by another player, which you then have the choice of accepting or declining. This would look much like the trade window popup you get just before you actually start to trade with somebody.
If somebody has duelling turned on then there will be a small symbol above their head so that everyone knows you accept duels.
I am undecided on whether you should to let your opponant see your duel rank before he accepts the fight.
Comments/Criticisms Welcomed, and a /signed for implementaion into chap 2 would be appreciated!

-THE M-