As of the latest edition of the game, armor falls apart extremely quickly to strong hits from superior metals, leather/bone is extremely cheap and multiple workshops in masterwork (notably from the kobold side of things) make use of these materials to great effect. Lots of cheap shoddy armor & goods was listed as a core suggestion point by yourself in the OP, this would help to address that.
How would we even be able to equip our large functionally immortal armies individually with precious metal armor if there are by chance no base metals within reach progression wise for the first year and enemies on our doorstep? Something is better than nothing. Especially out in the harsh wilds where goblins tend to encamp wheres there is usually a lack of one thing or another.
Also worth noting, that people will exploit the arena system to farm leather anyway once they realise how to do it as per the lower levels via deconstructing and re-constructing the arena separately.
Its not like people will get very far wearing bone and leather anyway. Though equipping our citizens with bone and leather goods (shields will probably not be that great post-new development build but decrease much slower like weapons, and leather cloaks are usually a good choice) does have some benefits.
Spawning giant demons as a reward and therefore 'instawinning' is pretty trivial by itself to counterargue, though i can't account for everyone, people will feel good for about 10 minutes then get bored that there is nothing challenging to fight with demons and practically no industry to promote extended building projects since the arena mode was the hypest thing about it. Thinking you've exploited the game makes players feel confident in themselves, which is why DF engineering projects gain such momentum like slade adamantium duping for instance, the guy (or someone else) went on to build a solid adamantium sphinx out of the stuff.
I have no objection to you drawing it out for the purposes of gameplay, but it does seem limiting of what you could do with it to make it so linear.