I have recently been experimenting with the in-camera HDR function on my Canon 5D MkIII, where the camera takes three frames 1, 2 or 3 stops apart and combines them into a single jpeg image with increased dynamic range (thankfully the three RAW files are also saved). My testing has shown that it's possible to achieve reasonably good results, but only with certain subjects. I didn't find that it worked particularly well with high contrast scenes (the sort where you might intend to use it!), as three shots just weren't enough to produce a natural result without visible halos. In such situations I found it best to stick to shooting images only 1 stop apart. Whilst this might not be enough to capture the full dynamic range of the scene it did tend to produce a reasonably good result without visible halos, and captured a little more detail than a single RAW file would have been able to. The resulting image also displayed less noise in the shadow areas, compared to a similar result achieved by pulling shadow detail from a single RAW file. It has to be said though, that a far better result can be achieved by combining a greater number of exposures using software such as Photomatix. In scenes with lower contrast the in-camera results were more consistent and it was sometimes possible to shoot images 2 stops apart and still obtain a pleasing result. In virtually every case I found the "art standard" effect setting to work best. As I was working from a tripod I kept the "auto image align" setting turned off, otherwise a small portion is cropped from around the edges of your composition. As the HDR image is saved as a jpeg it's important to expose the image carefully and to ensure you have set the correct colour space, white balance, and picture style in-camera. I normally set a custom picture style to enable me to adjust saturation, contrast and tone to suit each particular scene.
Unfortunately, when viewing the resulting jpeg image at 100%, the loss of detail from the jpeg compression is evident, especially when comparing it side by side to one of the saved RAW files from the sequence. However, if you're only printing up to a certain size (maybe A3) I doubt whether this would be particularly noticeable. If, however, you're keen to extract maximum quality from your images, you're likely to be rather disappointed by the output image.
I think it's still early days for in-camera HDR, but it’s possible that it could play a role in the future, particularly for landscape photographers. Once the camera is able to quickly combine a larger number of images (perhaps between 5-7 RAW files) into a single RAW file, this feature could perhaps achieve good results more consistently and therefore become quite useful. In the meantime I will stick to my normal method of controlling contrast, which is blending two or more exposures manually using layers in Photoshop.
Obviously a better solution would be for sensors to capture a wider dynamic range in the first place. Right now cameras equiped with Sony sensors certainly have the upper hand in this regard, but I'm hopeful that Canon will catch up. When I look back to the very restricted dynamic range of colour transparency film I have to be happy that all DSLR's are able to capture a much wider range of tones. However, I still look forward to the day when HDR, image blending and ND grads are a thing of the past!