In my experience, it's a slow death mostly. It manifests in two ways with the Pre 3:
1) Yeah, the amount of charge it holds dwindles away. Some of this isn't real, the battery just loses track of what "zero" is. There's memory of battery life in the controller for the battery. So it still helps sometimes to try and completely drain and recharge. This only resets what the battery considers "zero," however, so it doesn't report an almost dead battery too early. The actual capacity still decays with use though.
2) There's a really weird thing, too. It seems to happen more frequently as the Pre 3 batteries die. It's part of why I replaced my old one, and my newer one also did it once this past week: The phone suddenly gets totally locked up. You can't even do soft reset. Upon doing a battery pull you get a low battery symbol and have to plug it in. It's like some weird instant-death. Then you recharge for several hours and it's all fine again.
Like I said, I believe this happens more frequently as the battery ages, and it's easy to mistake as the phone being messed up. But once I got a replacement battery it stopped.
Finally, I'm wary of the Touchstone. The battery seems to be more well-behaved and long-lived when I use the Touchstones less often. So now I only use my office Touchstone and do wired charging at home.