I think you'll be fine with replacing the one damaged o-ring, Viton is the preferred elastomer as far as I know. It looked like there was a thin wire around the blade shaft? If yes, that's not what I expected to see... unless some other seal with wire reinforcement disintegrated? I'm not sure.
Anyway, Yes, if covering the port with your finger results in a hermetic seal I agree, the piston seal isn't leaking appreciably. Some small leak is nothing to be concerned with but what can happen is if the leak is large, too much exhaust can travel past the piston and burn plastic parts.
As you can see, the closer to the heat source, the more punishment the parts receive. And yes, the rubber seal on the blade shaft is intended to block hot exhaust gasses from entering the upper section while the blade is in the open position. While the blade is in the open position, maximum heat is being generated, thus the shaft seal (just an o-ring, I believe) helps to keep hot gasses from traveling up inside the body and causing damage.
Thus if it's only the one o-ring that's damaged, a replacement that's capable of withstanding the environment (Kalrez and Viton come to mind) will suffuce as long as the blade travels to the open position as intended. If for some reason the blade doesn't open properly, that o-ring receives more punishment b/c it's directly exposed to heat, it's not up against the body where heat is lower temperature.
Hopefully this explanation makes sense, lol.
If you see some parts damaged by heat, then do so. These elastomers will have to be replaced eventually due to the environment and trouble occurs if they're degraded and allow exhaust into the upper section. For instance, the plastic parts may be burned.
The blue button is the adjustment. The service manual I believe, suggests the correct position but if nobody has moved it just leave it as is. These aren't so critical as the other engines b/c the other engine rely more on spring tension where as the 951's the RAVE will either be engaged or disengaged by the MPEM computer.
The plastic piston is threaded onto the blade shaft fully till it bottoms, using finger torque should be sufficient and using a wrench to over tighten can damage the threads so not gorilla tight on that one, tight enough it won't work loose is the goal.