The Sonic waterfall is an example of dithering. If you degrade the quality of the signal enough (using a composite video signal, for example) the output will be

The Sonic waterfall is an example of dithering. If you degrade the quality of the signal enough (using a composite video signal, for example) the output will become blurry enough that the dithering blends together, and you can achieve certain special effects, such as the waterfall transparency. However, there is a big trade-off in the form of the entire game being blurry. That's why many enthusiasts back in the day (and today) preferred RGB output, even though the higher quality would ruin the blending of the dithered pattern. The Genesis/Mega Drive therefore supported RGB (Sega released an official adapter in Japan, and there was a SCART output in Europe). And, of course, if you were playing a game on a PC with a CRT monitor, dithering remained visible since PC monitors coupled with VGA signals were of much higher quality than composite signals on consumer TVs. It's definitely not the case that pixels could not be seen on a CRT - it just depends on the signal and the CRT type.