Because with this new proposed system, physical games were effectively just download codes. Which introduced several downsides for the many people who rely on discs, most notably the complex system involved in reselling physical discs.

Sure, this system made physical game ownership worse, but it made digital game ownership much better. Which Microsoft assumed would be a welcome tradeoff because consumers largely prefer digital games. But they had overlooked the large segment of consumers who are physical-first and do not care about digital games at all. Sure, gamers are largely gravitating towards digital games, but we are not yet at a point where literally everyone prefers digital. There are still some consumers who rely on physical for some reason or another.