Pyhmec published a very impressive video demonstrating his current work on the physics engine which illustrates a work-flow combining the Game engine and real-time playback in Blender 2.5.
Series of quick technical tests and demonstrations of some of the things I'm slowly working on.
In this series, I'm focusing on / almost exclusively exploiting Bullet Physics' (efficient) capsule primitive (see my previous Blender capsule videos). Everything is rigid body dynamics (no soft body). Still lots to do before I can turn this into an add-on; I also have some issues including capsules sticking to each other under certain circumstances, need to investigate. But over all it's working quite well so far.
For real-time (in Blender physics interaction) demo, go to marker: 7:15