I turned to F. Randall Farmer, a creator of the online multiplayer game Lucasfilm’s Habitat, for the origins of the term’s current incarnation. He and Chip Morningstar invented the game in 1986, when they also coined avatar in the “online persona” sense (though gamers had already been exposed to the word’s Sanskrit meaning with the 1985 computer role-playing game, Ultima IV: Quest of the Avatar.) “Chip came up with the word ‘avatar,’ ” he recounts, “because back then, pre-Internet, you had to call a number with your telephone and then set it back into the cradle. You were reaching out into this game quite literally through a silver strand. The avatar was the incarnation of a deity, the player, in the online world. We liked the idea of the puppet master controlling his puppet, but instead of using strings, he was using a telephone line.”
–On Language – Avatar – NYTimes.com.
Very nice, but — “toon” does not come from Toontown, Randy! I first heard it in connection with Sierra’s The Realm; I remember being slightly confused when some Realm players logged into UO and started talking about how small their toons were.
Most mudders, of course, referred to this as a “character,” taken from D&D, and that carried through into UO, since we were mostly mudder types. But to my mind, both the avatar and the character are the same sort of thing — a graphical version of what we tend to call a profile in a broader web sense. Be it icon, textual description, or a/s/l, it’s just identifying information.
It may be that Second Life is indeed why “avatar” is so widespread today, though I would be just as likely to give the credit to Snow Crash — a major inspiration to many of the virtual worlds of the 90s. There were bokos and conferences called “avatar” during this time period. Snow Crash frequently got mistaken credit for the coinage.
Another minor sidelight: a few years ago, the Oxford English Dictionary was running a project on finding the earliest citations of science-fictional words, and I did manage to get Chip & Randy proper credit. 🙂
It may be that Second Life is indeed why “avatar” is so widespread today, though I would be just as likely to give the credit to 
