OnLive, a Palo Alto, CA-based startup wants to do away with gaming consoles, game resellers, and the need to buy any more expensive graphics chips. Today the company announced a service that lets any computer run the sorts of graphics-intensive video games traditionally reserved for high-end gaming systems. Games can also be played on a TV using a small device offered by the company that connects a television to a broadband Internet connection.

The idea is to separate games from consoles or desktop computers, says Steve Perlman, founder and CEO of OnLive, a spinout of a Silicon Valley-based incubator called Rearden.

The intense computation needed to render each game happens remotely, in a specialized server farm with thousands of computers crunching numbers. But critical to the success of the venture will be a number of new compression algorithms developed by the company to let even the most graphics-intense games–including the realistic first-person shooter Crysis–render on a player’s screen in real time.

Perlman, who helped develop the QuickTime video compression format while at Apple, says, “You don’t need a high-end PC to run these games. The all-digital distribution means that you’ll never need to upgrade the hardware in your home.”

The idea of playing video games via the Internet is nothing new, of course. Companies such as Microsoft, Sony, and Nintendo offer online services that let players collaborate and compete over a broadband connection. But these games are still tied to their companies’ respective game consoles. World of Warcraft, a popular, massively multiplayer online game, streams content to a player’s computers via an Internet connection. But, as any player knows, one of the biggest problems with the game is that players must often wait for the on-screen visuals to catch up to their instructions.

“You still need a pretty respectable PC to run World of Warcraft,” says George Dolbier, CTO at IBM’s gaming division. “Games need to be very responsive to user so when you push a button, that game better react instantaneously; the big technical problem is when you push a button at home and it’s actually running at a computer potentially thousands of miles away, there’s going to be a lag,” Dolbier says. “Solving that problem has been a major challenge that Rearden has been aggressively tackling for some time.”

Perlman believes that OnLive’s compression technology can solve this problem. Most of the game processing and compression occurs where the powerful hardware resides: inside data centers with specialized graphics-processing units. Still, while compression schemes for video need only to compress data from a source to a viewer, video games need to compress data both ways–from a source to a player and back to the source–so that the servers can compute the next move. Without giving away too many details of the proprietary approach, Perlman says that OnLive’s algorithms consist of a feedback loop that constantly monitors the network that a player is using, trying to anticipate and adjust for the inconsistencies of Internet traffic.

Dolbier suggests that the compression algorithms used may also send as little information as possible over the network, anticipating variation from frame to frame with minimal amount of back-and-forth communication.

The basic requirement for running OnLive, says Perlman, is a 1.5-megabit-per-second Internet connection. But to run the service on a high-definition screen, he says, the connection needs at least five megabits per second. OnLive has already partnered with major games companies including Electronic Arts, Ubisoft, Take-Two Interactive Software, Warner Bros. Interactive Entertainment, and Epic Games. The company demonstrated 16 of its titles today at the Game Developers Conference in San Francisco, CA.

In order to use the service on a PC or a Mac, a person will need to download a one-megabyte program. To use OnLive with a digital television, a person will need the company’s MicroConsole device. The company will offer its own gaming controllers, but standard controllers can be used as well.

OnLive will be offered as a subscription service, says Perlman. When a person logs on, she can access a menu and choose games to rent, buy, or try. She can also watch other people play and play with others from around the world. Other features include the ability to record the last 15 seconds of play and share these “brag clips” with others.

By removing the need for expensive graphics cards for PCs and games consoles, OnLive “has the potential to dramatically open up gaming markets to people who wouldn’t have participated otherwise due to the initial cost,” says Dolbier. In addition, he says, OnLive could lower the cost of producing games (a single game can typically cost tens of millions of dollars to make) because it would only need to be made for one platform, rather than customized for Xbox, PlayStation3, and Nintendo. “It’s an excellent idea to expand the markets,” he says.