This is fantastic for kids or new coders. Its good coding practice, makes apparent the power of a simple, elegant algorithm, and has a big visual/fun payoff. You could spend weeks extending the concept.
There are tons of early examples of interactive 3D depending on what techniques and technologies you want to consider.
DragonStrike is most like a flight sim, of which the Microsoft Flight Simulator series dates back to 1976-77(for 8080 and Altair!), with FS 3 and 4, from 1988-1989 being most like DragonStrike in terms of tech. Contemporary examples within other genres include: Arctic Fox. M1 Tank Platoon, F-15 Strike Eagle II, Midwinter, Carrier Command, Stunts, and Test Drive III. "Flight sim" style 3D, with wireframes, flat polys and some sprites, was considered the main way to do interactive 3D for a long time, with each renderer having to pick and choose which details to focus on - the most common compromise being to impose heavy distance fog in order to convey detail in screenshots.
In the arcade, flat-shaded, color 3D was done in Atari's I, Robot in 1983! One year later, a simplified raytrace model was used to prerender terrain lighting for Marble Madness - a subtle solution to a problem that otherwise would consume a lot of artist time. Most of the 80's in arcades was dominated by sprite-scaling games with pseudo-3D road engine hardware like Outrun and Space Harrier, though. Wolfenstein 3D and Doom are in many ways more in the pseudo-3D genre than the flight sims, since they exploit a very specific hack with raycasting that gives decent quality and flexibility.
Edit: Wolf3D style raycasting was purportedly used in Alternate Reality: The Dungeon in 1986. You wouldn't know it at a glance, though, since it's a slow-paced RPG where your view is glued to 90-degree angles and snapped to the horizontal center of the grid cells.
If this is new to you, you should also investigate Perlin noise used to generate terrain. There are many examples online. It uses many of the same concepts although it's not quite as intuitive. I suspect it is more efficient, though, although that strongly depends on how good the PRNG you're using is.
I think that midpoint displacement is a well known technique. If that is a fractal or not depends on the definition of fractal that you prefer.
Anyway, it's a nice article. I like the graphs with the different values of the displacement decay powers. It's probably also well known, but the comparison is nice.
Better terrain generators will use higher-order curves rather than straight lines (i.e., instead of picking an increment for the midpoint and adding a multiple of 1 - |x|, add a multiple of 1 + cos(x)) in order to avoid having visible "corners". And of course terrain generators usually work in two dimensions, which makes this slightly more complex.
But yes, the "pick your dimensionality, randomly adjust the height in the middle, then recurse" approach is very standard.
Diamond square is often swapped out for Perlin noise in terrain generators. They give very similar effects, but Perlin's method is a little more flexible along certain parameters(e.g. arbitrary offsets, zoom-in) while diamond square has more control over the nature of features at different scales, which can be used to make terrain more or less noisy.
Yes, I think you could call it a fractal. The Wikipedia page linked to from the article says that this technique is also called a "random midpoint displacement fractal".
Midpoint displacement is mentioned in The Science of Fractal Images (and the Beauty of Fractal Images), and also in Mandelbrot's book Fractal Geometry of Nature.
The author fails to realize Diamond-Square is called such because a diamond inscribed in a square touch all the midpoints with each corner....very intuitive.
Whoever finds that these skylines look "realistic" spends to much time in front of a machine and too little time out in the mountains. This is ridiculous.
As one of the more popular terrain generation algorithms, it's a tool that gets used far too often.
Though to be fair, it's not only procedurally generated terrain that's wildly unrealistic in most 3D games. For the vast majority of games (except for, like, Arma), you'd think that the designers had never been outdoors.
And for a 3d example: https://goo.gl/images/JpSXTW
edit: a friend of mine wrote a game called dragon strike with terrain gen and I can't remember any real interactive 3d being done on a PC before that: https://extralives.files.wordpress.com/2013/09/dragonstrike_...
I'm sure there was prior art in some other pc game, maybe someone remembers...