if you look at the packaging for the xbox remote kit, you see all the dolby digital liscencing hooplah, this appears nowhere on the xbox' packaging..
This leads me to believe what I've read in another forum.. The dongle contains the dvd player code itself (in the form of an xbe?)..
Like powerben says, its a good a way of handling all the liscensing problems with both CSS and Dolby, and also handling potential problems with recalls.. (Remember when the original JAP PS2 could play movies from all regions, and the MPAA had a fit and made sony eat the cost of recalling those consoles?)
Also, unlike Sony, MS wasnt previously liscensed to make DVD players.. Sony can put dvd support in every PS2, cuz they have sort of an 'unlimited' liscense to make all the DVD players they want..
MS doesnt make dvd players, so I'm sure the dongle was just a solution for cheap liscensing.. ie; the xbox isnt a "dvd player" at all, the dongles are.