Lifehacker just published a list of their top 10 suggestions to use an old iPod in new ways. There are some of the more common methods (such as a making a basic stereo system by adding speakers or turning it into a backup drive) and some pretty inventive ones like as turning it into a standalone portable Windows XP boot drive.
As one of the readers at LH commented, the biggest missing suggestion is to give the old iPod to a friend or family member. That's exactly what I did with my first iPod. I took my eldest niece with me when I upgraded two years ago, then presented her with my 3G iPod when she expressed an interest it. Since then, she's received a new one of her own. The iPod I purchased then is now alternating between providing music in a home speaker system and in the car.
Have you found an inventive way to recycle your old iPods? Let us know in the comments!