How would the system be able to tell that the game is used?
The system would have to be online at all times (which in and of itself is a terrible idea), and each disc would need some kind of ID in it. When the disc is inserted in the system, the game's ID would be registered online along with the system's ID, and then that particular disc could only work after an online verification that this particular disc is in the right system. Unless they make their next console cartridge-based, then that whole process could be done within the cartridge itself... but that's unlikely.
When I first heard this rumor, all I could do was facepalm. It's already hard for game companies nowadays to make people spend 60$ on their games at launch, but making that the only option is just stupid. People will be less willing to spend 60$ on a game that they're completely uncertain if they'll want or not if they have no way to try it out beforehand, so niche games will die out and even the slightly less popular games now will have even more trouble finding an audience. Some people like lending their games to friends and stuff. Renting games will be impossible, and renting games is a GOOD thing for game companies (people can rent a game to see if they want it or see if they want to buy the sequel, in the end game rentals become potential profit for game companies). Add to that all the problems ffxik mentioned and it's clear to anyone that it's a terrible idea.
If this ends up being true, I don't see Microsoft staying in the console gaming industry very much longer. The only way this could work is if they end up selling the games for dramatically less than the competition... and that's not happening.