Both methods are valid (you forgot to include "3DS Max - Unwrap3D - B3d prog"), both have pros/cons.
MD2:
pros
Faster.
Use small amount of memory.
Supports non boned animation (warps and morphs).
cons
Can't remember exactly but there is some issue with lighting not working or looking bad.
No bones to hang things off (for guns, swords etc).
Can have jittery vertices.
Might not support multiple objects, textures, texture layers.
B3D
pros
Look great.
Can be manipulated at runtime using code.
Bones can potentially give you more accurate collisions.
Can be edited (after export) in lots of programs (fragmotion, pacemaker, unwrap3d etc).
Animation can be recycled for other characters in same game.
Generally more flexible.
cons
Having lots on screen can be slow.
The main reason not to use B3D (at least not all the time) is that they can be quite slow in medium to large numbers. You can of course switch to MD2s for far away characters etc. I would tend to use B3Ds until you find a reason not to.
MD2:
pros
Faster.
Use small amount of memory.
Supports non boned animation (warps and morphs).
cons
Can't remember exactly but there is some issue with lighting not working or looking bad.
No bones to hang things off (for guns, swords etc).
Can have jittery vertices.
Might not support multiple objects, textures, texture layers.
B3D
pros
Look great.
Can be manipulated at runtime using code.
Bones can potentially give you more accurate collisions.
Can be edited (after export) in lots of programs (fragmotion, pacemaker, unwrap3d etc).
Animation can be recycled for other characters in same game.
Generally more flexible.
cons
Having lots on screen can be slow.
The main reason not to use B3D (at least not all the time) is that they can be quite slow in medium to large numbers. You can of course switch to MD2s for far away characters etc. I would tend to use B3Ds until you find a reason not to.