I created something like that a while ago. But not with a blocky world. I used marching octats (or something like that, I can't remember) to proceduraly generate the "natural" looking world.

I created chunks of terrain. Every Terrain hat three lod steps. But the big problem was that the realtime modification needed to be done on the cpu, because directx9 doesn't support this nice geometry features in shaders.

For blocky worlds it should not be so heavy on the fps to recreate the terrainchunk. But my guess is, that it will never be so fluent like minecraft or other sandbox games.

Another approach would be using a shader. You create a terrain-chunk with all possible faces and hide those which are not visible. But collision will be a nightmare then. And the polygons are still rendered even if they are not visible.

Use another engine with nice advanced shader capability.