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Is it possible to define a bmap, draw to it during the game using pixel_to_bmap, convert it to a normalmap, and then use it in a dot3 bump mapping material effect?


It should be. But i imagine it would be very slooow.

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Is it possible to convert a bmap to a normalmap, and then draw to it?


no it's not. At least, you cant draw to it and preserve the normals data.

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what exactly is the difference between "material effects" and shaders?


material effects can use either the fixed-function pipeline or vertex and pixel shaders. Shaders are just the programmable part of the material effect.. you can have a material without any shaders, but you can't have shaders without a material.