Comment by nkohari

There are several CRDT algorithms (LSEQ, Logoot, WOOT, Treedoc) that try to properly solve the merging solution (your outcome #2) while still retaining the intent of the edits of each user. Their implementations differ, but the general idea is that each character (or chunk of characters) is assigned a key that can be ordered. When new text is added, it's given a key that is derived from the key of some adjacent text. As a result, the merge is the best-possible approximation of the intent of the edits.