This is not all that different from what many open source providers do (e.g., RedHat). If you want their official binaries, there are sometimes additional restrictions, but you are welcome to compile the source on your own or find a third-party who will provide you with unofficial builds (in this analogy, CentOS).
> "3.4 You agree that you will not take any actions that may cause or result in the fragmentation of Android, including but not limited to distributing, participating in the creation of, or promoting in any way a software development kit derived from the SDK."
Now, IANAL and maybe that doesn't mean what I think it means. To me it sounds like you're signing a non-compete agreement just by downloading the SDK.
That way, you won't be fragmenting Android - you'll be creating something new.
Then, should Android even stagnate, someone could take the source and create a new mobile platform, similar to, but not a different version of, Android.
What is and what is not a fragmentation of Android seems to be the key here.
It says you can't distribute any modified versions of the SDK. What you choose to call such modifications isn't addressed and isn't relevant, you just can't do it.
The confusion appears to stem from the fact that people are conflating the official, supported binary distribution license with the source code distribution license. These need not be the same. While easy access to binaries are convenient, it is certainly not a requirement of open source. And while it might be nice if every single thing in binary Android SDK was open source, this is also not an automatic requirement (depending on the license).
Reading the Terms and Conditions through this lens makes perfect sense -- the clauses about reverse engineering, distributing, developer key protection, all apply to the binary SDK. The source does not have these restrictions, and of course, statements like "reverse engineering" or "decompiling" can't possibly apply in the context of the source code in the first place.