Levels
Every spell, item, character, quest, and zone in the game has a level. The level determines the power of the spell, item and NPC. The level on a zone determines what level spells, items, NPCs and quests that you will encounter in that zone.
To level up your character you need to deafeat a boss of your own level or higher. If you play with companion(s) they too will level up when you do. Bosses are usually found in hard difficulty places in each zone.
Note that while your and your companions stats increase with level, the NPCs you encounter will have their stats increased by a bit more. This is to create a scaling difficulty curve. The exact slope of the curve is experimental and to be adjusted during beta testing.