My guess is that it's done digitally in the circuit that applies the surround sound algorithms, bass management, etc--ie in the DSP. I know for a fact that Wadia implements their balance and volume features digitally in DSP. Some sources with volume controls use an analog pot in the output stage but I don't believe I've seen one that implements balance in this manner. Gain scaling in the digital versus analog domains is a broad topic with many valid opinions on it. I firmly believe that, as long as you don't attenuate too much, digital methods are the way to go. For a balance control I can't imagine you applying more than about 3 or 4 dB of attenuation which should be transparent as far as overall resolution is concerned. The math says that for every 6 dB of attenuation there is the effective loss of 1-bit of resolution. This isn't necessarily true because you can play some tricks with dither, etc but it's a good rule of thumb. You have to also take into account that there are losses associated with analog gain scaling--you just can't assign a nice sucinct phrase like "bits of resolution" to it.
