Passkeys do not work with Microsoft 365

I'd say that, just like wavesound mentioned, Microsoft stills doesn't support passkeys for work or school accounts in Microsoft 365, and that's what's causing the issue shown in detail in sukka's post.

I went through exactly the same flow and got the same error earlier this year when I tried to register a physical security key which turned out to be incompatible. Once I had a key that was compatible, I was able to add it without issue.

Also, some other services, like Google, makes a clear difference between physical keys and passkeys already in the settings menu where you choose which method configure. I expect Microsoft to distinguish between the two by adding a method called Passkey in addition to the already present Security key method. It's just confusing to choose the Security key method and then choose between a USB device and NFC device when it's neither.