What I don't get is... what happens to touch? The whole point of the iPhone OS is touch. How does that work when you can't touch the screen? Isn't that the #1 issue? Or are we talking about a remote control that would effectively be an iPod touch?
http://www.apple.com/magictrackpad/
An iPod touch or an iPad would suffice as well.
Touch is just part of the UI layer. A D-pad for navigation and two buttons (Go + Cancel) are enough for a set-top box. I don't buy any of the "touch remote" theories, and I don't think games are going to be a part of the picture. In the casual games world, iTV doesn't have the same advantages over Wii that iPhone has over the Nintendo DS.