I'm guessing this is prevalent in Japan not because "all the good domains are taken" but because (browser) support for unicode domain names (IDN) continues to be patchy, especially on mobile browsers which, as far as I can tell, are especially popular in Japan. I'm guessing they've long solved the problem of entering Japanese characters with a tiny keypad for things like text messaging, and I strongly suspect that entering names in their native script is much nicer than entering transliterated or foreign names.
Besides, punycode isn't especially efficient. I suspect you quickly run into the DNS hostname length limit as well, as the number of punycode characters required increases with the numerical value of the code points to encode. I'm too lazy right now to work out how many Japanese characters you can maximally encode in a domain name. :)
Note: I don't speak Japan, have never been to Japan and am generally out of touch with Japanese culture. My first language (German) only uses a small number of non-ASCII characters, so I'm not exactly an expert on IDNs.
Unicode domain names could be implemented with a one way hash function with ascii output. That would solve the length problem. Depending on the hash algorithm, collisions would be extremely rare, and i doubt many domain names are already registered that are equivalent to the output of most hashes.
I guess it would be similar in a way to tinyurl.com
This obviously would only be a good option if the hash didn't need to be reversible. And I don't really see why it would be, since the dns system itself isn't perfectly reversible.
Adding a second mechanism is just not going to work at all, I'm afraid. How would the application know which encoding you're trying to use? There's also no clean way to solve the reverse DNS issue with hashes.
Besides, it took long enough to get IDNs out "into the wild", and they're still struggling. IE6 still doesn't support them out-of-the-box, so there goes about half (or more) of your non-technical audience. I use exactly one site with an IDN regularly, http://öbb.at/ - the rail company here, and they actually advertise their other, non-IDN domain, oebb.at, presumably due to lack of browser support.
Besides, punycode isn't especially efficient. I suspect you quickly run into the DNS hostname length limit as well, as the number of punycode characters required increases with the numerical value of the code points to encode. I'm too lazy right now to work out how many Japanese characters you can maximally encode in a domain name. :)
Note: I don't speak Japan, have never been to Japan and am generally out of touch with Japanese culture. My first language (German) only uses a small number of non-ASCII characters, so I'm not exactly an expert on IDNs.