I suggest it be built in a creative mode server or else a tekkit server, because in plain minecraft, people end up spending way more time getting resources, fighting over resources, organizing resources, and distributing resources than they spend using resources.
If we want plain minecraft creative, then let's at least wait for the next update, so we get script blocks for the clever players to use.
As for what's being built, no matter if it's above, on, or below land, water, or magma, it should be designed so that players can just hop on and build something without too much trouble. A more traditional city works for this better than a structured fortress; once the streets are layed out, anyone can claim a block (or set of blocks) and fill it in.
I propose a cavern city by an underground sea of some kind. Map modification may be suitable, though changing the world generator would probably not be
Other potentials include extreme hills, a borehole city (volcanic!), or a traditional grasslands city with a dwarfy theme.
If we really want a dwarf fortress, then we can still establish crisscrossing tunnels and vertical access shafts, but I warn that the city would look boring unless it's built around a large void like an artificial cave.