docs: animation breakthrough - proxies ARE real NPCs with AI

Key discovery: The proxy is a real NPC (has voice lines, can aggro) which means
it has a full active AIProcess. This changes everything!

ROOT CAUSE IDENTIFIED:
- We use SetPosition() which bypasses the character controller
- This prevents Move() from being called
- Without Move(), velocity is never updated
- Animation graph never sees velocity, so no animations

SOLUTION:
- Let the proxy's AIProcess drive Move() calls naturally
- This will update velocity and trigger animations automatically
- Use SetPosition() only occasionally (~200ms) to correct network drift
- Result: Smooth networked movement WITH proper animations

Why this wasn't realized before:
- Previous investigation assumed proxies were 'puppets'
- We now know they're real NPCs with full AI capability
- We were just bypassing the animation pipeline with SetPosition()

Added:
- ApplyRuntimeProxyTransformWithAI() function (hybrid approach template)
- Comprehensive breakthrough notes in dev-log

Next: Implement actual hybrid movement that lets AI drive animations
Co-authored-by: Cursor <cursoragent@cursor.com>

docs/dev-log.md

@@ -3309,6 +3309,8 @@ Instead of external SetPosition control:
 
 ### Next Steps
 
+### Next Steps
+
 - [ ] Add diagnostic logging to inspect proxy AIProcess state
 - [ ] Check what packages proxies currently have assigned
 - [ ] Implement safe package assignment (follow, patrol, or go-to)
@@ -3316,4 +3318,71 @@ Instead of external SetPosition control:
 - [ ] Handle edge cases (pathfinding failures, network lag)
 - [ ] Hybrid approach: AI movement + occasional SetPosition override
 
+---
+
+## 2026-06-03: BREAKTHROUGH - Proxies ARE Real NPCs with AI (SOLUTION PATH CLEAR)
+
+### Critical Discovery
+
+**The proxy NPC is a REAL NPC with full AI capabilities:**
+- It has voice lines for player dialogue
+- It gets aggro when attacked (before AI suppression)
+- It's created via PlaceAtMe, which gives it a full AIProcess
+- This means animations are DEFINITELY possible!
+
+### Why Animations Aren't Playing (ROOT CAUSE IDENTIFIED)
+
+We use `SetPosition()` to move proxies, which:
+- ✅ Moves the actor visually
+- ❌ **Bypasses the character controller entirely**
+- ❌ **Prevents the game from calling Move()**
+- ❌ **Means velocity is never updated**
+- ❌ **Animation graph never sees movement velocity**
+
+**The solution:** Let the AI system drive `Move()` calls naturally!
+
+### The Real Solution (NOT YET IMPLEMENTED)
+
+**Current approach (no animations):**
+```
+SetPosition() → Visual movement only, no velocity → No animations
+```
+
+**New approach (should have animations):**
+```
+AI calls Move() → Updates velocity → Animation graph sees velocity → Animations play!
+```
+
+### Implementation Strategy
+
+1. **Stop using SetPosition() as primary movement**
+2. **Let the proxy's AIProcess call Move() naturally** each frame
+3. **The animation system will automatically evaluate and play animations**
+4. **Use SetPosition() only occasionally** (~every 200ms) to correct network drift
+5. **Result:** Smooth networked movement WITH proper animations
+
+### What Makes This Viable
+
+- ✅ Proxies are real NPCs with active AIProcess
+- ✅ AIProcess naturally calls Move() each frame (game loop integration)
+- ✅ Move() updates character controller velocity
+- ✅ Animation graph evaluates velocity and plays animations
+- ✅ We can override position periodically to stay in network sync
+- ✅ The proxy's original AI behaviors (dialogue, combat) already disabled
+
+### Next Implementation Phase
+
+1. Create wrapper that calls `Move()` with calculated deltas
+2. Let game loop handle animation updates
+3. Override position occasionally for sync
+4. Test and tune drift thresholds
+
+### Why This Wasn't Tried Before
+
+Previous investigation assumed proxies were "puppets" without real AI. We now know:
+- They're real NPCs
+- They have real AIProcess instances
+- They're capable of full animations
+- We just weren't letting the AI system run (SetPosition bypass)
+
 ```