The generated key would work with a backup copy of the game CDs, but only on the original computer. Basically the game would check the computer it is running on when started, rather than a play CD (which would no longer be required). If the computer was upgraded too much or a new system bought, a new key would have to be requested. The downside to this is that if the developer / publisher ever goes out of business or drops support for the game, you would be unable to play the game on a different system.
The key generation would work about the same way Windows / Office XP activation does. The game would examine the computer hardware, generate a key based on that information, and compare it with the key provided by the developer / publisher. If too many differences were found, it would refuse to run without a new key. If it is done right, there are not really any privacy issues, since the code the game would generate could not be used to work backward and get information about the list of hardware used.
