New Vegas managed to introduce a complete overhaul of the way music was handled over even Fallout 3. While Fallout 3 finally introduced the ability to create new music groups (instead of hardcoded "dungeon/town/wilderness/battle" that Oblivion had), it was still not that much of a leap. New Vegas's MLC introduced region-customized battle music, changed music according to the local faction's opinion of you, and also differing tracks according to time of day.

However... in New Vegas, this new system was, IMO, squandered on rather lackluster music that was not really much more than background noise like the wind or crickets. They even abandoned in place several music tracks that were specifically meant for areas, like Freeside or The Fort, in favor of said bland ambient music, or even forewent classic Fallout music for again said bland music like the Khans' hideout (Why didn't they use Khans of New California? That's classic Khan music).

Will we be seeing a return of this music control system in Skyrim? It's quite a nice uprate from Fallout 3's from a mechanical perspective, it was just that the content it handled in New Vegas was meh.

The problem with dynamic music is, as you say, blandness. If you have lots of determiners for what track is being played, and this track has a definite, recognisable melody to it, then it can sound quite abrupt when one of the determiners changes (night descends, for instance) and suddenly a new tune is being played. Think of the jarring way Oblivion's sudden implementation of combat music panned out.

This is hard to avoid. The more seamless you make the transition, the more bland the music. Fable 2 tried to go with an ambient music system and ended up with one of the least memorable soundtracks of any game ever... except for the melodious tracks that always play in a given area. Fable 3 went for a much more melody based track and its music was much better received (just about the only thing that LH managed to improve rather than screw up there).

By all means have slightly different versions of tracks based on time of day, but don't go overboard on the determiners or you'll have to sacrifice the assertiveness of the music itself like in F:NV.