DVD upconversion is nice, and it beats regular old SD DVD, but it is limited. The image is recorded in digital 480p, which is incidently what the X360 internal DVD player is capable of playing all DVD's at. When you use an upscaler, the player is "filling in the blanks" for the non-allocated pixels on the displayed image. In other words, if the previous pixel is sequence is 8, 6, 4, 2 (this is hypothetical) then the upscaler will fill in the spaces in between with 7,5,3 in order to use all available pixels. While the image generated is infact 720 or 1080 in pixels, the source doesn't actually have the data.Therefore, it isn't as good or tight a picture as a true HD source, like HD-DVD or Blu-ray. The X360 HD-DVD player also upscales DVDs, which can allow you to compare the two sources directly and see the difference, which can be striking. The source material also makes a big difference, as some things are more easily upscaled. For instance, movies with lots of CGI and artificial backgrounds (say, 300) are likely to look almost as good from a DVD upscaler as a true HD source. A more realistic film, (say The Departed) will not.
The stuff about HD signals over component cables is a real quagmire. You can send HD signals (1080p) over component (The XBOX 360 HD-DVD player does!). Most new TV's, and many new DVD players will not send or accept the signal, because the manufactureres have restricted them. This has to do with manufacturing agreements. The only legal issues that arise are terms of use agreements, and this is more likely to affect broadcasts than prepackaged media. The HDCP hardware is not currently in use, and their are no (announced) plans to use it, though industry pundits predict it will become active in 2010 or 2011.
As for the difference between 1080p over component or HDMI: This comes down to personal choice. Their is little difference in actuallity, though HDMI will offer a signal with less variability and is therefore techniquely probably the superior technology. The difference is not nearly as profound as many people suggest, and either is fine option. HDMI is simply future proof.
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