This morning at the PAX East Microsoft breakfast, Larry "Major Nelson" Hryb revealed the 16GB Xbox 360-branded Flash drive from SanDisk. Available in May, the not-yet-priced device comes pre-installed with the April 6 Dashboard update for those who shun the connectivity of Xbox Live.
In a conversation with Joystiq, Hryb informed us that all data will be transferable to the USB device, except for installed games -- users will need to re-install those directly to the USB device once more. He assured us, however, that, "If you've got a 16GB and you only want to use 8, you can use the UI and throttle it back." Further, he reiterated to Joystiq that while this branded device is certainly one option, other Flash drives (including those larger than 16GB) will work in the same capacity.