I ran into the same problem, having just started with MySQL. Didn't want to settle for clear passwords and after doing some research it seems to point to .NET 4's change of hashing algorithm from SHA1 to HMACSHA256 (based on this discussion:
http://tinyurl.com/2g6fcp8)
This may not show on some machines - mine is clean Vista with VWD 2010 Express, and I didn't run the Connector/NET install, rather just using MySql dlls in the same directory. Maybe the install sets up some ASP.NET config files accordingly somewhere.
Anyway, I didn't have time to investigate further, so I resolved the problem by putting this line in my web.config's system.web section:
<machineKey validationKey="AutoGenerate" validation="SHA1" />
Apparently this forces MySQLMembershipProvider to use SHA1. For some reason adding hashAlgorithmType="SHA1" attribute to membership/providers/add element didn't work -- it just wouldn't get picked up.