Setting Hostname

The host name is really just the name of your computer, like your PC at home, or your server in this case. It can be called anything you want, like 'george' or 'sally' or even 'server'

However the FQDN (fully Qualified Domain Name) consists of your hostname + your domain name.

li1xxx.xxx.members.linode.com is the default FQDN that comes with your linode, and is owned by linode.

li1xxx.xxx is the host name (probably)

members.linode.com is the domain name (well sub domain name, as linode.com is the real domain name)

You must own the domain name, you can't just make something up.

So if your linode is only a play thing and you don't own a domain name, then no, you can just use li1xxx.xxx.members.linode.com

It's often good practice to set a hostname as it'll help identify the server being reached - its especially helpful if you have more than one machine being interacted with often. It's not absolutely required, but it's way easier to remember a domain name than it is to remember IP addresses.

There's also some good reasons explained on serverfault.