Difference between web reference and service reference?

The low-level answer here is that a Web Reference will create a client proxy class that allows your code to talk to a Web Service that is described via WSDL and communicates via SOAP or HTTP GET (other posters indicate that it is only ASMX, but Web References can also talk to Java-based Web Services or Python-based or Ruby so long as they all talk WSDL and conform to the WS-I interoperability standard).

A Service Reference will create a client proxy class that communicates with a WCF-based service : regardless of whether that WCF service is a Web Service or not.

The service reference is the newer interface for adding references to all manner of WCF services (they may not be web services) whereas Web reference is specifically concerned with ASMX web references.

You can access web references via the advanced options in add service reference (if I recall correctly).

I'd use service reference because as I understand it, it's the newer mechanism of the two.

Service references deal with endpoints and bindings, which are completely configurable. They let you point your client proxy to a WCF via any transport protocol (HTTP, TCP, Shared Memory, etc)

They are designed to work with WCF.

If you use a WebProxy, you are pretty much binding yourself to using WCF over HTTP

Another point to take in consideration is that the new UI for Service Interface will give you much more flexibility on how you want to create your proxy class. For example, it will allow you to map data contracts to existing dlls, if they match (actually this is the default behaviour).