I have always been under the assumption that mkv playback on the 360 was impossible and an error message would appear if you tried to play any mkv file. I distinctly remember getting this error message when I first got my xbox and never tried to play another mkv file.
I just tried the other day to play an mkv file streaming from my desktop and to my surprise it worked. But, the resolution was down-scaled A LOT, the picture was very pixelated, and the audio was down-scaled from 5.1 channel to 2 channel. Along with that, the playback seems to be very slow which leads me to believe its being processed by software rather than hardware.
Am I crazy or has this always been the case? And for the record I tried searching but didn't find anything.
EDIT
Totally ignore this. Didnt realize my TVersity was set to transcode on the fly. My bad!