I'll try and explain this so that it is clear, but if I don't make any sense I apologize.
Digital Zoom is not a zoom in the sense that it is making the image larger to the camera. Digital zoom blows up the center portion of the picture and crops the rest. The more digital zoom you use the more it crops.
You could effectively do the same thing by taking i the picture without the digital zoom and cropping it in photshop and blowing up the cropped image. The digital zoom is useful if you do not wish to do this in photoshop (or a similar program).
The digital zoom will not allow the camera to take more pixels than the ccd of the camera is a capable of, so yes you could say that the digital zoom lowers the quality of the picture by blowing it up.
This article explains it much more clearly than I do
http://www.photoxels.com/article_zoom.html