The Mg-5Zn-2.5Er matrix composite reinforced with the in-situ synthesized Mg2Si second phase particles was fabricated via repeated plastic working (RPW) process. The microstructures and the nanocrystals in the composite have been investigated using transmission electron microscopy (TEM), high-resolution transmission electron microscopy (HREM) and energy dispersive X-ray (EDX). Great deals of nanocrystals were found in the matrix, and they were around the in-situ synthesized Mg2Si. The HREM analysis showed that the size of nanocrystals was in the range of 5-10 nm, and the difference in their crystallographic orientation was bigger than 15°. It is suggested that the formation of nanocrystals in the matrix is attributed to the RPW deformation process and to the intensive stresse fields around the in-situ synthesized Mg2Si particles, which suppress the growth of nanocrystals by forming nonequilibrium grain boundaries containing disordered dislocation networks and junction disclinations.