As outlined on the FreeDesktop.org page, Xephyr was written a number of years ago as a possible Xnest replacement and to be used for tool-kit debugging, X.Org Server development, and for creating a multi-seat setup.
Haitao has written to the X.Org mailing list asking about the future of Xephyr and KDrive. Xephyr hasn't been maintained well lately, but Haitao is interested in taking over the duties after he and Robert Bragg, a fellow Intel engineer, wrote the "Design and Implementation of Xephyr with OpenGL Acceleration" design document earlier this year (it was made available on MeeGo-SDK in September).
However, if Xephyr is deemed as having a little future ahead, Feng will cease development on it. Meanwhile, the Intel engineers working on MeeGo Touch are busy looking forward to the Wayland Display Server.