Wanted to bump this thread since I'm still very interested in the idea, and had some new suggestions with the recent development.
Since the time I posted this, MineTest added its LUA API and games structure, which makes it possible to create your own game with the engine. I'm very interested in using MT to create games of my own with completely new items / blocks / mobs and ideas. However, I'm dreaming to eventually make some with full 3D models and without the blocky looks an low-res textures, in which I'd really want correct smooth terrain.
Here are some demos of something I wanted to do with OGRE (not mine) and might consider doing with the MT engine instead, in terms of terrain. Basically, I've been aiming for a while to make a game like MineCraft... but with smooth surfaces, high-poly 3D meshes for items, and the same mechanics and gameplay as MC / MT. Those videos are just for inspiration BTW, so I'm not suggesting it should look exactly like that. The words used in this case are marching cubes and metaballs.
http://www.youtube.com/watch?v=3hSVjqsXPOohttp://www.youtube.com/watch?v=7xTUvElNTj4Anyway, the new suggestion I wanted to add is making smoothness a feature of certain blocks, and not a rendering option. This will allow people to make both blocky and non-blocky materials in custom games, plus properly calculate collisions so you can climb diagonal ramps for such blocks. Blocks with this feature enabled would merge with each other, while those without it would stay the same as now.
Another idea based on something I looked into recently; Bezier curves. I learned that those are an awesome way of doing this sort of thing, and generating smoothness based on spatial points. Neighboring blocks can use each others corners as points, and generate a bezier curve surface instead. A map editor for Quake called gtkRadiant (or netRadiant which is a fork still under development) allows exactly this under the name 'patch meshes'. Curves are probably not necessary though.
Oh, and something else I noticed: There's already a system to do something similar (but for another purpose) in MineTest, called farmesh. It causes distant blocks to connect and appear as continuous surfaces, in many cases diagonal ones. It's possible that code from there could be used and simply given a smoothness property. Also note that flowing water / lava do something similar already to block shapes, though again it's just one level of smoothness (a diagonal surface).
Especially with the custom games feature, I really support and would love to see this idea implemented, and really hope someone might try it in some form. If done as a block property, it might be possible to get by with a simple implementation (eg: the way fences deform to connect with each other, or the way flowing water deforms).
[EDIT] There's already something that does this for MineCraft. It's called MViewer. It has a feature for smooth terrain exactly like my suggestion.
http://www.youtube.com/watch?v=Twat21yn6WY Also, another great example is the project Voxelaria.
http://www.youtube.com/watch?v=4-4RlUARHLM