The feature, which Joystiq says is due out in the next few months as part of the spring system update, will turn any USB-based storage device--be it an external hard drive or a flash drive--into a memory source up to 16GB, which will work just as the Xbox 360 hard drive and memory units do. This includes allowing users to copy games to these devices, instead of having to spin up the 360's disc drive, as well as saving Live Arcade games, movies, and downloadable content.
Though according to Joystiq, users with a USB hub and a handful of cheap flash drives shouldn't get too excited, as the system limits the number of USB mass storage devices to just two. This means you can have two 16GB partitions handy, for a total of 32 extra gigabytes of storage on top of whatever hard drive you've got. This should still be welcome news for people with Xbox Arcade units, or launch systems with 20GB of storage, who do not feel like shelling out for Microsoft's pricey add-on hard drives.
As for what this means for Microsoft's Xbox 360 memory units, which use a proprietary plug and currently top out at 512MB, it would seem their time on this earth is numbered.