Xbox – use games already installed on Xbox 360 hard drive

One of the benefits would be that your disc will get less wear and tear. You still need to put the disc in, but after verifying it, it shouldn't be read again (though that will depend on the game). This should minimize the danger of scratching it if the console gets knocked. There should also be less noise as it doesn't need to keep the optical disk spinning.

You might also get faster loading times - but that would depend on the game.

An obvious downside is that you are going to fill your hard drive if you do this for all your games.

Yup, you can actually use up to a 16GB USB Storage Device for use with your XBox 360, assuming it has the software update that went out in Spring of 2010:

1. Connect the USB device to a USB port on your console.
2. Go to My Xbox, and then select System Settings.
3. Select Memory.
4. On the Storage Devices screen, select USB Storage Device.
5. Configure the storage device. You have two options for configuring your USB storage device for Xbox data storage:
   1. Erase all existing data, and configure the entire USB storage device.
   2. Configure some (but not all) of the USB storage device's memory (up to 16 GB).

For more information, have a look at the how-to guide on the XBox website: --> http://support.xbox.com/en-us/Pages/xbox-360/how-to/usb-flash-drive.aspx

Billy ONeal asked why there's an arbitrary 16GB limit. The official FAQ doesn't really address this, but instead tells you how grateful you should be ;-)

Why does Xbox 360 only support 16GB of storage, even though I have a much larger device?

Supporting USB storage devices up to 16GB in size is a huge increase in storage over any solid state memory storage solutions currently available for Xbox 360. Users that need more storage have options in the Xbox 360 hard drives, which are available for purchase separately.

However, it should be noted that you can use up to two USB Storage Devices, for a maximum of 32GB total size.