Correct me if i'm wrong but as far as I know PS3's backwards compatibility was hardware based and a big part of the high price of the system and we all know how that ended for Sony. To the point it was eliminated from the PS3 in ensuing revisions.
So, the original PS3 consoles had backwards compatibility through two elements of the PS2 hardware being made part of the PS3 chipset: the Emotion Engine (CPU) and the Graphics Synthesizer. I believe that by the time the system launched in Europe, the Emotion Engine was already ripped out (but it could still play some PS2 games through partial emulation of the missing chip?), and then the next major global revision removed the Graphics Synthesizer, and PS3 could play no PS2 games.
en.wikipedia.org
...But then, an interesting thing happened where Sony, out of nowhere, released a couple "
PS2™
Classic " games to PSN in 2011: God Hand, Maximo, Odin Sphere, and Grim Grimoire. There's just shy of 100 of these PS2 Classic games now on PlayStation Network to buy.
It was assumed at first these were recompiled specifically to play on PS3 (because most figured at the time that PS2 emulation on PS3 was not feasible without the real hardware,) but hackers dug into the game files and found that they were in fact the PS2 games running on a PS2 emulator for PS3. They then modified that PS2 emulator, and while it's not perfect, it can run a percentage of PS2 games on a jailbroken PS3.
Playstation Development Wiki - PS5, PS4, PS3, PS2, PS1, PSP, Vita Information
www.psdevwiki.com
I've played with none of the hacked stuff BTW, so I'm going off of other people's impressions and some video clips of its functionality.
I do, by the way, have a PS3 with original backwards compatibility (I believe it was a standard launch unit, but I might have waited for the MGS4 version,) and I got to say, it kind of sucks? The controls seem off (though maybe that was HDMI lag being introduced; I remember the God of War 2 QTEs were unplayable, and I had to pull out an old PS2 to play through it), and the display quality was okay but not enhanced with the hardware obviously.
I wish there was a market for a proper PS1/PS2 player (would have been a more worthwhile buy than the PlayStation Classic machine,) but those days are pretty far in the past now and Sony never really went fervently into the a classic gaming digital market the way Nintendo or even Microsoft did.
In short, the PS3 was the most backwards compatible console Sony ever made and almost ruined the company. The PS4 is the less backwards compatible console Sony ever made and was a huge success. And people still don't understand why Sony doesn't go all in with BC.
Pfft, that's a LOT of conclusions jumped to there...
It has to be digital only given I find it highly unlikely that the PS5's BluRay drive will support CD's.
Oh, shoot, you're right -- a PS4 won't read Compact Discs. That's weird, I know HD-DVD dropped the format but a Blu-Ray laser should be able to scan the disc just fine (if you plop a music disc in, it can tell it's a disc but calls it an "Unsupported Format".) I wonder if it really cannot read CDs or if Sony just skipped any access drivers to save a penny or avoid hacking access points or something?