The resolution and bitrate are actually quite amazing ( due to the fast processor inside the iPhone 3G)
If you want a free movie to try out go here
http://revision3.com/diggnation/2008-09-13hotels/
Download the Large quicktime file
It has already been encoded to play on your iPhone
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a few side notes ( for the nerds)
The theoretical maximum specs for video for the iPhone are 640x 480 at 1.5mbs/ second
the M4v files you download from iTunes however break this rule, they are 853 X 480 (16:9) and have a bitrate of 1.6mb/sec or higher
Im not sure how, but the content from iTunes has a higher bitrate and resolution then what is possible
In anycase, the highest resolution videos can play on the iPhone are 480x 320 , or in 16:9 480x 270
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Youtube quality is really not that good over wifi, even worse the bitrate is dropped when you go on 3G.
"YouTube resizes your videos to 320x240 pixels, encodes them to Flash 7 at a data rate of approximately 250 kbps and compresses audio to mp3 (22.050 KHz, monophonic)"