From DNJournal:
Paul Twomey, the President and CEO of ICANN, said today that rushing to add non-English characters to domain names could literally break the Internet. Twomey said ICANN (who is in charge of the global domain name system) is under a lot of political pressure to quickly make domain names available using local alphabets around the world but that more testing is needed to make sure that can be accomplished while allowing the Internet to continue to work without problems. Domains that use foreign characters (known as International Domain Names) currently use an underlying puny code that consists of standard English characters. If ICANN works the technical issues out (which they are expected to do before the end of 2007), puny codes will not be necessary and a true multi-cultural Internet DNS will emerge. Twomey, a native Australian, made his comments while speaking today in Sydney.
http://dnjournal.com/lowdown.htm
Q: Are they saying that punnycode domains will be obsolete/useless and real language domains will replace them?
This is nothing new. The early idn harvestors were holding onto BQ code before they swapped for XN code. Rather, the implication will be on link marketing, using unicode to link instead of punycode.