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Just like a real arcade the Arcade Version of the X-box means you can't save games.
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The arcade version of the 360 comes with a memory card so you can save game progress and unlockable characters etc.
If you don't use x-box live, you won't need a hard drive but you'll need it if you plan to pay for for downloadable content. You also don't get backward compatability without a hard drive, but you're better off skipping the hard drive, and using the money to buy an original x-box for this anyway.