A new method to create vertex weights for bone deformation was added, next to the existing method based on envelopes. The new bone heat method often generates better results, and does not require setting a radius for bones.
It can be used when parenting a mesh to an armature by selecting "Create From Bone Heat" from the available options. After parenting or adding an armature modifier, it can also be used in the combined weight paint and pose mode, using the W key, and choosing "Apply Bone Heat to Vertex Groups".
The implementation is based on section 4 of this paper:
Automatic Rigging and Animation of 3D Characters
Ilya Baran and Jovan Popovic, SIGGRAPH 2007.
An improved CrazySpace correction is now used for Armature modifiers that use vertex groups, and that are the first enabled modifiers in the stack. This is a a specific case, but also a common one. The correction is exact in case of simple vertex groups, and locally exact when using them with b-bones. Envelopes are still only approximately corrected.
A new option to interpolate rotations with quaternions was added. This reduces artifacts of linear blend skinning, such as shrinking on large rotations, but is also somewhat slower. It can be enabled in Armature panel as the "Quaternion" deform option for armatures, or in de Armature modifier for meshes.
The implementation is based on this paper and the code provided with it:
Skinning with Dual Quaternions
Ladislav Kavan, Steven Collins, Jiri Zara, Carol O'Sullivan.
Symposium on Interactive 3D Graphics and Games, 2007.