The Service may only be accessed with an original Xbox, an Xbox 360 console, a personal computer, or other device authorized by us, or by logging into your account via Xbox.com . You agree that you are using only authorized software and hardware to access the Service, that your software and hardware have not been modified in any unauthorized way (e.g., through unauthorized repairs, unauthorized upgrades, or unauthorized downloads), and that we have the right to send data , applications or other content to any software or hardware that you are using to access the Service for the express purpose of detecting an unauthorized modification. Any attempt to disassemble, decompile, create derivative works of, reverse engineer, modify, further sublicense, distribute, or use for other purposes the Service, any game , application, or other content available or accessible through the Service, or any hardware or software associated with the Service or with an original Xbox or Xbox 360 console is strictly prohibited and may result in cancellation of your account and/or your ability to access the Service, and the pursuit of other legal remedies by Microsoft. Microsoft may take any legal action it deems appropriate against users who violate Microsoft's systems or network security
http://www.xbox.com/en-US/legal/LiveTOU.htm
Pretty clear to me what they intended. Even if you didn't pirate, xbox live is only meant for unmodified machines. Play at your own risk if you fussed with the innards.
Happiness is twin floppies.