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Are you using PSP? Most all of the animations I see in PSP are grainy. Not sure why. You might: A. Check your resolution...normally for the internet 72 is good enough, but you might bump it up a notch. or B. Can you check your color mode? It needs to be RBG not indexed color. ??????? Wish I could be of more help.
ETA: To answer your question, no. I am pretty sure it has to be saved as a .gif for animation to work.