Don't worry gamers, a fix for your banned Xbox 360 is coming.
No ETA for fix, but modders are hard at work

Every fall Microsoft tends to try to find ways to ban Xbox modders from its Xbox Live service.  Microsoft detests modding, as it allows users to accomplish forbidden activities, such as playing backups of games, playing out of zone DVDs, installing alternative operating systems, or playing pirated games.

This holiday season Microsoft has a special surprise in store for "naughty" Xbox 360 hackers -- a particular sweeping ban that relies on spotting modified drive firmware.  Rolled out starting last week, the ban, according to sources, blocks the installation of games on the Xbox hard drive, blocks the Windows Media Player media extender, corrupts saves/Gamertags used on the machine, and most significantly prevents the console from accessing Xbox Live.

According to early estimates 600,000 consoles were effected, but more recent estimates put the number at close to 1 million consoles.

Microsoft has suggested that users with banned consoles find another Xbox.  However, users with a banned Xbox 360 may not want to throw away their consoles just yet.  According to the site 360Mods, c4eva has abandoned work on his Lite-on and Hitachi drive mods to try to establish a workaround.

The new workaround, dubbed iXtreme LT (Light Touch) aims to provide a minimum amount of security checks and aims to make the firmware as close to the stock firmware as possible to prevent detection.  This fix may allow modified consoles to return to playing backup discs and other forbidden materials without Microsoft noticing.

Other members of the community are working on strategies to try to undo the changes made by Microsoft, which neuter the banned consoles, depriving them of much of their functionality (though they still will play games offline).  Like Apple's attempts to brick unlocked/jailbroken iPhones, it seems only a matter of time before the creative and dedicated community comes up with a full work around.

Correction:  Earlier we posted a link to an older version of iXtreme, indicating that the software was done.  It is, in fact, not yet done.  We will issue an update when the patch is released or when other workarounds are completed for the banned Xbox 360's.

Update: Friday, Nov. 13, 2009 12:30 p.m.: 

A fix appears to have arrived, according to some of the forums, but it is rather complex and requires access to either an Xbox 360 you know the CPU key of, or did not update over the summer.  According to user k0mpresd on Xbox-Scene:
what you need:

your 8955 live console + cpu key
a 2nd unbanned console
nandpro b + flash cable
xell loader
1888 fs
robinsod's flashtool


use nandpro and dump nand from unbanned console.
flash xell and use jtag hack to obtain cpu key.
use flashtool to extract file system.

dump nand from 8955 console.
use flashtool to patch nand dump with kv.bin from unbanned console.
save patched file (patched_kv.bin).

open degraded + 1888 fs.
create 1888 downgrader image (downgrader.bin) from your patched_kv.bin file.

flash downgrader.bin to 8955 console.
attach hdd + ethernet cable and boot console.

connect to live and update to 8955 dashboard.

console is now fully working and unbanned!

Again, this relies on a variety of free tools, and can be a somewhat complex process.  You are using the key to gain access to keyvault on the unbanned console.  Without the key you will not be able to access the keyvault to transfer to the banned console.  Also, it may not be wise to log the fixed (banned) Xbox 360 on to Xbox Live at the same time as the console you grabbed the keyvault from.  Some users are suggesting this could result in the ban of both consoles. 

Restoring your console may add to the EULA and legal violations you may already have committed and we do not recommend  or condone it in any way.

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