I personally prefer local storage solutions, but you can’t ignore cloud storage, services like Steam have worked well for years, OnLive is holding it’s own pretty well and even the Xbox 360 is “doing the cloud thing” these days, so it’s a safe bet that Microsoft will be taking this further.
There has also been a floating rumour that the Xbox 720 will include Blu-Ray disc support, which Microsoft already refused to add to the existing Xbox 360, although there has been no official confirmation, yet. There’s even been an expressed desire for the return of HD-DVD’s, but with cost of Blu-Ray drives now being so low, it would be suicide to try bring another format back from the grave and/or turn their back on a tried and tested one.
If Microsoft decides to truly implement the security features preventing used games and eliminate the use of discs in the new console then a large amount of storage space will be needed. Most modern games take at least 4GB of storage space, which is no small amount. New games, especially games that use even higher definition textures and graphics, would take even more storage space akin to what we’re currently seeing on modern PCs (12GB+).
If a need for more storage space arises there will be no possible solution other than to include local storage options, which would ultimately result in larger hard-drives being bundled with the Xbox 720. Hopefully this would also translate to Microsoft opening up storage options to allow third-party hard drives and external storage options like what is seen in the current PS3 model. Microsoft does currently allow users to take advantage of external storage drives on the Xbox 360, but there are limitations to what the external drives can do – one of them being Xbox 360 games cannot be installed to external drives.
Either way I’m going to put my money on a solid-state drive (SSD) with more versatile cloud backup, with some form or another of Blu-Ray, even if it’s not support for movies, but just for the extra disc storage.
As for not being able to play used games, similar systems are already well rooted in the PC industry, so it’s not that big a leap and online-pass isn’t going away any time soon, could we get hit with DRM that requires an internet connection? I hope not *shudder*.
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