Here's the message from the XDR owners forum, you can still use HiDPI resolutions, but the scaling is limited.
What is interesting here is the scaling is limited to the exact width that the LG 34" 5K2K is limited to.
So I think it is essentially a software limitation that may be informed by the hardware, but I imagine if a tool like SwitchResX worked on Big Sur M1's and we could modify the *.plist files, the machine could drive it.
The total amount of pixels being driven when the M1 has the internal display running at HiDPI 1680x1050 (True Resolution: 3360x2100, Total Pixels: 7,056,000) alongside the LG 52k2 in HiDPI 3008x1269 (True Resolution: 6016x2538, Total Pixels: 15,268,608) is lower than running the LG 34" 5K2K in clamshell mode.
The combined pixels run in that configuration is 22,324,608 compared to the pixels rendered in the desired LG 5K2K resolution of HiDPI 3840x1620 (True Resolution: 7680x3240) of 24,883,200.
However, if you take the XDR Display and run the same sums you get the same figures for the internal display, but the XDR is driving 6016 x 3384 (Total Pixels: 20,358,144) pixels (either in native mode or HiDPI 3008 x 1692). Here, the total number of pixels being driven by the M1 is 7,056,000 + 20,358,144 = 27,414,144 total pixels
So, using the existing hardware we can confirm with 100% certainty that the Apple M1 Macbook Pro/Air (8-Core GPU) can drive sufficient pixels to power the LG at the desired resolution.
What we cannot confirm, is that it can drive both the internal display and the LG 5K2K at the same time. Perhaps Apple doesn't want to offer a resolution that cannot be operated alongside the internal display.
If anyone has figured out how to apply resolution modification on the M1 Mac's please shoot me a message! Thanks.