It's been a couple months since the PS3 2.70 firmware update, but we've finally gotten the chance to test out the external video storage. In two words: it works.
You can back up your purchased videos to any external USB drive, be it a flash drive or a standard USB hard drive. The video will show up on in a backup folder inside the drive, but you can't stream directly from the drive. So it's not like you can connect a 1TB USB hard drive and dump all your movies onto there for on-the-fly watching. You're limited to whatever space you have on your PS3's drive for storage, but you can swap in/swap-out from the external drive with relative ease.
So yeah, nice job Sony for putting out this video backup. It's great for the person who downloads a lot of movies from Sony's PSN service, which has a surprisingly decent selection for a service that's not that old.