On April 6th, Microsoft will be releasing a system update over Xbox LIVE for the Xbox 360 that will allow USB flash drives to be used for storing profiles, game saves, demos and more.
Once you take the system update on April 6th, you'll be able to connect your USB flash drives to your console and head over to the memory section to configure your new storage device. Once you do that, the system will conduct a one time performance and integrity check to confirm the drive is working properly. You will then be able to configure how much storage to use on the device, up to 16 GB. The remaining space on the flash drive will be accessible by your PC or Mac. USB Hard drives may work, but like flash memory, you'll only be able to use up to 16GB of space.
Notice that the system won't just configure the device once it is connected to the console. You'll need to head to the memory area in system settings, select your USB Device, and choose from Configure Now (Format and Configure the Full Device), or Customize (you can choose how much memory you want configured for Xbox360 from the free space on the device.)
While any flash drive can be used, Microsoft is partnering with SanDisk to release an Xbox 360 branded USB flash drive in May that comes pre-configured out of the box and ready to go.
Microsoft also said that it has also enhanced the memory management functions, so you'll be able to have better control on what you want to copy or move between storage devices.