Given that the first screen is a logon screen, I'd guess that the field with the key icon is your password. Why you think that this refers to an encrytpion key is beyond me, especially since the key isn't actually generated until a later stage. It even looks like a password field, with the password starred out.
The key generation being strengthened by "entropy from your mouse movements and keystroke timings" is just a variation on a theme, where some additional inputs are used to add randomness to the key being generated, e.g. TrueCrypt does something similar.
Note that they state that "You hold the keys to what you store in the cloud, not us". This suggests to me that the encryption key for the files is stored by the user, a move designed to prevent third parties accusing them of knowlingly infringing copyright? If they are storing encrypted data only and have no way of decrypting that data to find out what it is, they really can argue that they are not liable for the content they host since they cannot even view that content. Some would say that this is a sensible move, not only in a self-preservation sense (they really don't know what the user is uploading so they can't be held liable for it) but also because it should, if implemented correctly, ensure some degree of security for the end-user's data - even if someone manages to get access to the servers where the data is stored, all they get is a load of encrypted data.
One question that springs to mind is: If all the data is encrypted and the key is stored at the user's end, how is this going to replicate the success of megaupload? You can no longer just upload a file and post the URL, you now also have to post the key so other users can decrypt the data. It's not a huge extra burden, but it's one more hoop to jump through and may discourage the less technical users from using the site unless they make it really easy to use. There are some hints that you'll be able to share files and folders with other users, but part of the success of megaupload was that you didn't need an account to download stuff.
It'll be interesting to see how this all pans out and whether this is a real change of direction from the original megaupload. It certainly sounds like they're moving from a free-for-all file hosting model to more of an encrypted file system approach with access to the service limited to registered users only but I guess time will tell.