Looking at my M1 MBP, I believe the vertical resolution of the Touch Bar is about 60 pixels with the Touch Bar height of about 10mm (including the bezel). The current height of the top bezel is about 12mm. I suspect that the Touch Bar functionality is leaving the keyboard and finding a home above the traditional screen. The additional 16 pixels comes from no longer needing a bezel around the Touch Bar. When you account for the physical escape key and the Touch ID/power button, you've accounted for the space of the notch. To me, this is the only way adding a notch makes sense, and offers a way that it will go unnoticed much of the time.
When in use, you will have your normal rectangular screen. One configuration will likely leave the menu bar intact and allow for Touch Bar-like inputs above the menu bar. Then when you enter full screen mode, the menu bar will go away and drop down into the tabs taken up by the Touch Bar-like interface.
I think Apple is sold on the contextual options, but have learned that putting them on the keyboard is not where users would like to see them. It's an evolution of the old Apple ideal of a modular interface that made use of palettes of varying sizes needed for different apps. Now, rather than using slide-out trays and drop down menus, they are pulling some of the those contextual items out and placing them above the display where they are easily accessed, yet out of the way.