The bootloader uses compressed data files which are kind of like a zip file but are arranged more efficiently for random-access use. This uses a Linux library called squashfs, but as it's GPL there's no real reason the mksquashfs couldn't be ported to Windows.
This filesystem for each application can actually be used to contain any Linux program, not just python programs, but as the python-ps3 system (in rootfs.sqf) already contains a python system, the file for an application needs only contain the code for the application (source code or compiled) and data for images and sound. For instance, the clock demo is about 200 lines long and only takes up 16k on the memory stick.
Additional games can just be packaged into a single .SQF file and dropped onto the memory stick and they'll automatically be detected. The python-ps3 libraries are similarly upgradeable simply by putting the new version of rootfs.sqf onto the USB drive.
My next step is to make the development environment accessable as an application, accessing files on another machine using NFS. This means that any computer with an NFS server will be able to be used for development (even Windows). Currently, I have a full Linux system running on my development PS3 doing exactly this, just not packaged up as an application.
Obviously, I'll continue to make announcements as this progresses, although I'm crazily busy until just before Christmas which is why I released the alpha version now instead of sitting on it for another 2 months. It'd already been pretty thoroughly tested in its current form, just not quite with all the features I wanted in it!
Yeah, it's built on the python-ps3 framework I'm working on, which is meant primarily for games but can be used for pretty much anything really.