I'm surprised that this is actually an issue, can someone who is more familiar with the Android OS explain how the space available was consumed? Is it simply a matter of adding tons of new binaries?

I believe that each new update takes up more space.

When my G1 was upgraded to Cupcake, it started slowing down. What I did was I uninstalled a number of apps and deleted a number of photos and my G1 was snappy again.