Abstract This paper discusses the compression of digital video signals at bit-rates around 1 Mbps for interactive playback applications. The coding algorithm is required not only to provide good-quality reconstruction of complex material but also to facilitate interactivity with the bit-stream at the decoder. The algorithm proposed in the paper is based on the well-known technique of motion-compensated prediction and DCT-coding of the prediction error. This basic approach is considerably enhanced with motion-compensated interpolation of skipped video frames and selective coding of the interpolation errors. The interactivity requirements are met by partitioning the video sequence into segments each comprised of a small number of frames. Different ways of encoding a segment are examined. An arrangement is selected that has one intra-coded frame in the center of the segment and a symmetrical pattern of predicted and interpolated frames on the two sides of the intra-coded frame. Segments of length 9 and 15 frames are evaluated. While the shorter segment leads to faster interactivity and simpler decoder implementation, the associated picture quality is much inferior to that obtained with the longer segment. Finally, a rough design of the decoder, suitable for VLSI implementation, is outlined.