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The touch screen is the natural progression, it shaves off size and weight, it reduces the amount of buttons required and overall it is simpler and more intuitive to pick up. Needless to say, it isn't perfect and there are flaws, but I think the touchscreen would be very appealing to a lot of users, myself included.
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I think Touch would alienate some users, too. My seventy-three year-old father would throw a touch-screen e-reader across the room (I saw him do it with an iPhone that his one of his grandchildren thought he would use). But he absolutely loves reading on his Kindle 3. Why would you alienate that entire demographic by requiring more manual dexterity to operate it (in the case of reduced size and the number of buttons like you suggest)? Just keep a basic, non-touch e-reader available--in addition to the latest & greatest whizbang--and
everybody will be happy... no?