Forgive me, I haven't read everyone's responses.
While I agree that the picture itself is likely not real, the concept could very well be.
Some have argued that it would be too small to be useable, keyboard would be useless for typing, etc. Have any of you tried to type on some of the "smart" phones out there? The ones that have 2 letters per tiny button? I would argue that, with some practice, a scaled-down iPhone keyboard would be very usable.
Some have also argued that many key "smart phone" features, such as internet and email capabilities, would be lost in a form factor this small. My question is why? I have a small flip phone, the actual body of which is much smaller and thinner than this device would be, and it has these capabilities. Some people don't need the full "smart phone" experience (the work-from-your-phone experience). Why is it so incredible that there could be something less than a business-class smart phone on the market?
I think many of the responses have forgotten what a "concept" design really is. Just because it's not a "real" photo of what may be released doesn't mean the idea doesn't have merit and even possibility. I certainly wouldn't want an iPhone with the dimensions of my iPod Nano, but a slightly smaller form-factor for the iPhone would be welcomed by many, I believe.