Whether you like the Nine Inch Nails or not: You have to admit that they put a lot of effort into their Internet activities and that they were at the forefront regarding free downloads of albums by major artists.
Using the title „The best selling MP3 album of the year was free“, The Long Tail writes that the NIN album “Ghost I-IV” was the best-selling MP3 album on Amazon in 2008, with US$ 1.6 Mio of revenue in the first week. Even though you also could download the album for free, legally. These are quite impressive numbers, and this is an interesting development I didn't quite expect.
Of course, the question is whether this could work for relatively unknown artists as well. I think selling CDs is most worth it for smaller bands if the band sells the CD at the gigs. Maybe a double strategy could work where you can download the album, but also offer a physical CD that offers the benefit of being tangible, having a nice booklet etc. I'm not sure whether it could work for smaller bands to have free and for-pay downloads. I think you'll need a bigger fan base for that.