So what physical medium will Microsoft be using for their next gen console?

[Mummelmann]

It depends on when the next generation starts. A console fully based on downloads is still impossible, there are only 5-10% who have a decent connection so being forced to use the internet to get every game is out the window for quite a few years.
Blu-Ray would make sense, DVD's will be outdated by next gen at any rate and there aren't really a lot of high capacity, HD alternatives.