I'd imagine that he was actually charging you for the extra effort as much as doing something sketchy. While the card does provide an additional layer of security, it also provides a layer of convenience for the locksmith, as they can just punch your code into their machine and it will spit out a copy very rapidly.

It sounds like you were talking with someone who had a clue and could quickly, but with additional effort, reproduce a key via a duplicator like this: http://www.lockpicks.com/w333l-sidewinderkeyduplicator.aspx which is fine, but dramatically less convenient than an automated code cutter.