No, you don't actually need a hardware DVD decoder if your system is "fast enough". In order to play software DVDs well, you need a system that can enable DMA on the DVD drive, have about a 300 Mhz processor or greater and a graphics card with motion compensation support.
I was able to play DVDs with excellent results using an AMD K6-2/300 and ATI Rage Pro (which has motion compensation). When I had a Banshee (which doesn't have motion compensation) in there, playback got a little choppy in some scenes.
Any DVD drive should work with any hardware or software decoder. They are just like CD-ROM drives. They use supply information -- they don't have anything to do with decoding.
Regarding the CT7160 DVD decoder. These are picky about which video card you use. You have to have a graphics card that has a feature connector and have drivers that support the VPE interface (overlaying video data directly into the graphics memory through the feature connector). The image quality played back on the monitor is highly dependent on the drivers for both the DVD decoder and the graphics card.
TV output quality was excellent however. In fact, I use this card to make back up copies of HK DVDs that I have bought so my uncle (who doesn't have a DVD player) can view them. I then give my mom the original DVDs to play on her DVD player.
For viewing DVDs on a monitor, the best results I had were using the Luxsonor reference drivers on an ATI Rage Pro. The quality was probably a slight notch below the Sigma Designs Hollywood+ but was still excellent. For some reason, the Creative Drivers don't produce very good monitor DVD quality (lots of aliasing effects) on many of the graphics cards I tried.
Other graphics cards that I've gotten it to work with are those based on the Riva128, Banshee (but only the Creative Labs version), Savage3D, Savage4, and my new Cardex Geforce2 MX card.
The Cardex Geforce2 MX card seems to be the best card to use with the Creative Labs drivers.
For Win2K, there are WDM (originally written for Win98 but works in Win2K) drivers that I have gotten to work with the Savage4, ATI Rage Pro, and Geforce2 MX cards. Image quality on the monitor was not good on both the Savage4 and Rage Pro but was surprisingly good on the Geforce2 MX (except for a horizontal red flickering line on top of the screen).
Luxsonor (the company that made the chip in the CT7160) has release their WDM source code so hopefully somebody out there will be able to write better drivers for it. I personally think this is an excellent DVD decoder -- it just needs better drivers. I love the idea of using an internal ribbon cable to digitally overlay the video data into the graphics card. This avoids the video degradation that is experience with the Hollywood Plus cards and their pass through cable.