Does anyone know how Half-Life 2 does bullet holes? Especially for dynamic models and stuff. For example, if I pull out a crowbar and have a spasm on a matress, I can pick the matress up with the gravity gun, kick it around and stuff, and the holes jiggle along with it. I thought they'd probably just use a transparent quad on it, but I'm not so sure anymore. Any ideas?

They probably do use a transparent quad (often referred to as a 'decal'), but subdivide it if the geometry underneath it is complex. I imagine that it is similar to when you shoot the corner of something.