I think the thing that fools us here is the fact that we're used to pixels being discrete, so it doesn't "look" low-res because the colors blend into each other

I think the thing that fools us here is the fact that we're used to pixels being discrete, so it doesn't "look" low-res because the colors blend into each other. If you imagine that each LED produces a small circle onto the diffuser, and that this circle overlaps the ones around it a bit, it gets easier to see through the illusion. It's much easier to understand when you can change the distance of the diffuser to the panel (which I did when testing), because then you can see the lights go from little squares with lots of dark space around them, to this, to big blobs of one color.