My kids have their own iPod Touches, as do we both. They got them for Christmas, aged then just under 6 and 10.
They are FABULOUS. They use them for audiobooks, watching films or TV (BBC iPlayer works on them), playing games, reading. My 10 yr old also uses his to help with his schoolwork - he goes to a French-speaking school, so uses apps to help with translation and verb endings for his homework, apps to practise times tables, etc.
He reads on his all the time, as do I - they are great little portable e-readers - and has a preference for puzzle solving strategy games with elements of history and science.
The games for it are brilliant, ranging from free to just a couple of pounds for things that would be £20 on a DS. I don't download games that require shaking as part of the game play to limit dropping, nor do I get him first-person sniper-type ones, as these seem a bit 'nasty' to me.
We haven't had any problems with inappropriate internet use as kids here (Switzerland) seem a lot less streetwise, or maybe it's just mine. The only videos they watch endlessly on YouTube are 'Arthur' and 'Horrid Henry'.
It IS a big gift and I understand about the spiralling expectations, but it was made very clear that it was a one-off last Christmas based on their dad having a US work trip at the end of the year and it being much cheaper to buy them there. On the other hand, they don't have DSs, mobiles, TVs in their rooms or the latest gaming systems, things owned by many kids in their classes at school, so they do understand that they don't/won't have everything.
A case is essential - my kids have sort of silicon jellyish feeling ones, which feel quite shock absorbent - as are rules are where they can be left when not being used (ie, not on the floor). They haven't so much as scratched them yet, though.