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The nearest you get to 1080p, the better the (upscaled) result will be. It's better to go to highest you can, even if it's an unusual resolution than to stick to a straight 720p that is only half the resolution.

And for why not directly a 1080p, as far as I read, the slow memory of the XOne requires to make a good use of the very fast esram, which is also very limited in term of space. The better the resolution, the more you will need memory or slow down the process with transfer from/to the main memory. That's a balance they can't really overcome, because what ever gain they get from optimization, they are using it to draw better graphics or improve framerate (for a better result, but also to be on par with the PS4).