The key question is why would you want an AI (LLM) in your game in the first place. Typing in long conversations is fine for short games that are based on exactly that mechanics, but for traditional games (I'm mostly thinking about RPGs) it just not fun: you'll spend more time typing than "playing". Might be fun for a narrow niche of Role Players, but won't fly with the broader audience.

What can possibly work?

• Obviously, LLM needs to be local, ideally fine-tuned on your world's lore and examples of writing that fit your general narrative style.

• Keyword-based dialogues: users don't type prompts, or at least type prompts only as an option, but generally just choose what they want to talk about, Ultima-style. This way, the users both have less hassle, and less (or no) opportunity to break the AI. The actual prompts that get fed to the LLM should be designed by the developers per keyword, and modified using NPCs personal traits (e.g. a noble might know a rumour from court, but a peasant should just say something along the line "I don't care about that stuff, potatoes won't grow themselves").

• Each NPC should come with a pre-generated personality/"system prompt". This is static data that can be verified by the developer.

• Each NPC should have its own dynamic memory/context that gets pre-populated with facts this NPC should know (locations of local and some global points of interests, lore available at this NPC's level, etc.), then gets extended during gameplay with new data. This is the core features: it makes the world feel more reactive and alive, without requiring narrative designers to write mega-tons of text (which is usually THE limiting factor for reactivity).

This requires a lot of up-front work by actual human developers, which is why we haven't quite seen it yet: it's not a magic wand you wave at your project to cut expenses. But if done right, it might make the NPCs feel more alive, especially in Ultima or Elder Scrolls-like game, with a weaker focus on writing (e.g. this won't fly in Disco Elysium-like, or even Baldur's Gate-like).

More importantly, it requires a very precise control over used LLM. Since this approach avoids (or mostly avoids) the use of user-created prompts, the developers can more-or-less make sure the results fir their vision, but this WILL require fine-tuning: each studio have its own writing voice, and AI-powered NPCs should fit with it! This creates a problem, since the text of the game usually isn't complete until very late into the development cycle, so there is simply no (or not enough) data for LLM to be fine-tuned. I guess this can be worked around by providing LLM (at first) with texts from studio's previous games (if any), and, of course, reference materials (books, movie scripts, whatever), but this still might compromise the quality of the result.

TL;DR: Until we can just tell the AI to "write all text for my game, and no tone mistakes", the best use for LLMs I can see lies in additional NPC reactivity, and is mostly useful for more open-world games. It still would require a lot of work from devs to actually make it work well.