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In this letter, a network-coded cooperation scheme with dynamic coding mechanism (DC-NCC) is proposed. In DC-NCC, the relay dynamically adapts forming the network-coded data based on the observed instantaneous source-to-relay channel quality, and then forwards the network-coded data towards corresponding destinations. Under the assumption (denoted as A) that each destination can reliably overhear the data from other sources, the diversity-multiplexing tradeoff of DC-NCC is proved to outperform that of conventional cooperation (CC), This verifies that DC-NCC outperforms CC in bandwidth efficiency. Moreover, DC-NCC offers reduced system outage probability and single-pair outage probability compared with CC, and achieves the same full diversity order as CC at high signal-to-noise ratio (SNR). Numerical results also show that with dynamic coding, DC-NCC avoids unnecessary error propagation which can be caused by coding those erroneous data into network-coded data. Finally the performance of DC-NCC is discussed in case the assumption A is removed. For a wireless network composed of N source-destination (s-d) pairs and a single relay node, although there is a certain outage probability increase for each s-d pair, DC-NCC still achieves a diversity-multiplexing tradeoff superior to CC.