What's the current state of Magic: The Gathering online play?
There are two typical ways to play MTG online: 

With the official client, where you spend money and build a collection of cards, just like with paper cards, except virtual. The community is very strong. The last number I seem to recall was that MTGO creates about as much revenue as the global paper MTG (and that was back in 2007), so the online player population is about as large as the offline population, except everyone is in one place, so it is infinitely easier to find a game at any given time. Managing large collections and building decks from it is of course also much easier.

The other way is to try one of the countless free clients out there, some of which provide rules checking. I'm not well informed of that scene, but a quick google search should get you started in no time. Of course, there is not much of a collecting aspect there, because you just put together your deck from the whole pool and play, but OTOH it's absolutely free, financially.

As for having a collection aspect AND doing so more or less free: AFAIK you could do that in the official online game. Money buys you tokens, and tokens buy you cards and entry fees to tournaments. In tournaments, you can win tokens. So, as the legend goes, if you're good enough, you can "go infinite", basically playing and increasing your collection for free. The existance of such players has been doubted, however, and I've never played MTGO, so I wouldn't know for sure.