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Microsoft - XBOX Arcade SKU - View Post

You can pick up a 20gb HDD, or a 120gb HDD. Try getting 'em second hand, you save a few quid doing so.

And, yeah, any USB HDD/Your iPod will work fine

Bearing in mind that you get a 256mb memory stick with an Arcade (only works for game saves, and storing offline profiles - you need an HDD for LIVE).