When it comes to shooting digital photos, you've had three basic choices. You can use your phone, a compact point-and-shoot camera, or a digital SLR.
There is certainly a range of capabilities within each of those categories. But, broadly speaking, all of the devices within a given category have a pretty similar set of tradeoffs relative to the devices in another category.
When it comes to dedicated cameras, point-and-shoots don't have interchangeable lenses, have relatively small image sensors, tend to have a perceptible lag between the shutter button being pressed and the picture being taken, and usually have poor or nonexistent viewfinders. But they fit in a pocket.
For their part, DSLRs take higher-quality images and generally afford a much higher level of creative control but are big and heavy, especially once you start talking multiple lenses and other accessories. A modest DSLR kit can easily add up to 10 pounds or so and fill a small bag.
Tradeoffs of this sort aren't really new. At least after cameras started incorporating a lot of electronics, a similar bifurcation happened among film cameras as midrange rangefinder models like the Olympus 35 largely disappeared as a category. But there's an additional wrinkle with digital. With film, all these cameras had the same "sensor," namely 35mm film, whereas with digital, point-and-shoot cameras are also burdened with a relatively small sensor.
Even high-end compact cameras like the Canon Powershot G12 and Nikon Coolpix P7000 have 1/1.7-inch sensors, which translates into a sensor area of 43 square millimeters By contrast, the APS-C format that is widely used in low-end to midrange DSLRs has an area of about 370 square millimeters. That's over eight times the area and sensor area has a lot to do with overall image quality, especially in dimmer light. (35mm "full frame" sensors such as in the Canon EOS 5D Mark II are over twice as large again as APS-C.)
But a new category of camera has put in an appearance. It's often referred to as the Micro Four Thirds category. That's the name of the standard created by Olympus and Panasonic used by the most prominent early examples of cameras positioned between compacts and DSLRs.
The original four-thirds system was created by Olympus and Kodak for DSLRs and the Four Thirds consortium now has a number of additional members including Sony, Sigma, Leica, and Panasonic. It specifies a sensor size of 225 square millimeters, a little over half the size of an APS-C sensor, but still much larger than that used in compact cameras. (This sensor size also means that, while depth-of-field is somewhat wider than with an APS-C or 35mm full-frame sensor, there's still much more opportunity to control focus than with a compact camera.)
Micro Four Thirds retains that sensor size but specifies a design that eliminates the mirror box used in DSLRs. The somewhat smaller sensor, combined with the elimination of the mirror, allows for camera designs that are significantly smaller that DSLRs while retaining significant flexibility and creative control.
Referring to the entire tweener category as Micro Four Thirds isn't really accurate though. The tongue-in-cheek "EVIL" (for electronic-viewfinder-interchangeable-lens) speaks to a broader range of camera designs that fall under the same basic design philosophy.
Electronic viewfinder refers to the fact that a photograph has to be composed using the image falling onto the sensor rather than one that's bounced to an optical viewfinder by way of a mirror. This latter approach is what's used by a DSLR; the mirror is then quickly flipped out of the way when the shutter button is pressed.
While the picture can be composed using a back-panel LCD display as is often done with compact cameras, this isn't really a very stable way to hold a camera and can also be hard to see in bright light. Thus, EVIL cameras usually come with separate eye-level electronic viewfinders that mount on the camera's external flash hot shoe. This is one of the downsides of current cameras in this category; the electronic viewfinders feel like awkward bolt-ons and also add about $200 to the system price.
For its part, Canon has seemingly suggested that it favors an approach that retains the mirror and thereby retains an optical viewfinder. Masaya Maeda, head of Canon's Image Communication Products division, said in a Reuters interview, "It's not a question of whether or not you have a mirror. There is a consumer need for good-quality cameras to be made smaller."
So it's a still-developing category. That doesn't mean there aren't solid products; the Panasonic GF1 perhaps best fulfills the promise of this class of camera today.
But the early entrants are expensive--perhaps $1,500 for a kit with a body, a couple of lenses, and an electronic viewfinder. That money would buy a solid midrange DSLR with a larger sensor. And you have to buy into a camera system in a space where the players are still shaking out and, indeed, the two DSLR heavyweights, Canon and Nikon, haven't yet unveiled product plans.
That said, it's an intriguing area of development. Sensors and other camera electronics can do more in less space all the time. For example, in-camera electronics that compensate for lens distortion--and thereby potentially allow for smaller lenses--are coming onto the scene. And this trend should help to enable cameras that retain many of the advantages of today's DSLRs in a smaller, lighter package.
What remains to be seen is whether a new class of camera such as Micro Four Thirds goes truly mainstream or whether we see something more like a downsized extension of DSLRs. And whether this creates an opportunity for new entrants to make it big or whether the traditional heavyweights end up co-opting the space instead.