I wonder to what extend the real issue is Taiwan. After all China has a (often strongly expressed) territorial claim to Taiwan (and vice versa, but that is not as well-known). If China were to cede alleged land-rights w.r.t. to these islands, it might set a precedent that Taiwan might try to exploit. Maybe China wants to avoid this situation.
I think they're both related to upholding territorial claims, which the PRC says is a "core interest" (ie, something they're willing to go to war over), but I don't think it's viewed as a direct domino effect.
The more direct link is potentially to the CCP's claim to legitimacy as the government of China. If they can't defend China's "historic" claims to territory then they could lose legitimacy in the eyes of an increasingly nationalistic public.
I agree, but it would be much easier to sell giving up on the Spratly Islands to the Chinese population than accepting Taiwan as a sovereign state. Indeed I would not be too surprised if China did the former. The ability to do so gives China a lot of leverage in negotiations with regional or international competitors, just like the US uses the unresolved Taiwan situation as a lever in negotiations with China.
