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I am not familiar with the X-Box, but I bet it does the job of storage and playback pretty well.
Does it have a digital output? If so I would consider buying an outboard DAC (digital to audio converter) to improve the sound.
Or, strip down an old computer by taking off all the programs except your music program, get a sound card with a digital out (preferably one that will deal with 24/96 files), use your dac or buy one for less than $500 and get ready to listen to amazing music. Heck, I just use my receiver dac as I am still trying to get up and running after the flood.
Trey
I agree with elk, just buy a Music Fidelity V-DAC for $299 or an HRT Musicstreamer for $99 from Musicdirect.com. Assuming the xbox360 you have has an optical output? Then run a pair of RCA cables from the DAC output to your receiver/amp. This should offer a decent bump in sound quality.
Unfortunately this scenario won't address any concerns you may have about the xbox360's reliability and sometimes prone hard-drive failures. Or the limitations with music library management if this configuration.
Another option would be to buy a Logictech Touch and utilize your home PC and the Squeezebox server software. This would be a fairly inexpensive option also that will put you on a better upgrade path later down the road.