Video files in an SPO document library - not O365 video or stream

With the Office 365 Video API you are only able to access content in the Office 365 Video Portal. If you have a independant document library with assets, you are not able to use the Video API to access those assets.

The reason Office 365 Video and Stream down scale your videos, is because when bandwidth does not allow high bitrate playback, there's an automatic fall back to lower bitrate streams of your video. Every uploaded video is transcoded to a couple of streams, to support multiple screen sizes and bandwidth scenarios. If your original video is full HD (1080p), then Stream will keep a 1080p stream of your video as well, and if bandwidth is sufficient, will offer that stream to the user. If your video has higher resolutions than that, indeed the max resolution of Stream is 1080p and your video will be down scaled.

The visual indicator you are mentioning, is actually part of the Azure Media Player that both Office 365 Video and Microsoft Stream are using for playback. That media player also checks bandwidth, screen size, your location in the world, decrypts the video stream, etc. and then offers a decrypted version of the right stream from the right caching location. A whole lot of plumbing that makes the use of Office 365 Video and Microsoft Stream so interesting opposed to creating your own solution ;-)