I think the joystick thingy is a bit retarded. I would rather just see a full controller like Xbox 360's that you could use via bluetooth if you are not satisfied with touch controls. I mean if you are willing to carry around this small joystick thing, you would probably carry around small controller also and that wouldn't take screen space from already small screen. If you have Wiimote and jailbreaked iPad, you can download SnesX or similar emulator from Cydia that have Wiimote integration and try it. It's pretty cool to play Super Mario with Wiimote on iPad
I think you can't replace external controller with touch. It just doesn't work because you can't get any tactile feedback. And I count your hands and body as external controller also so I count motion detection like Kinect as external controller. In my opinion only games that follow the traditional point and click formula works with touch. And if you have device with accelerometer, then you can do racing also but in my opinion that only works properly with bigger devices like iPad. With iPhone your hands are just too clamped up when you play with tilting as steering.
