Analog Or Digital
Analog or Digital?
The Squeezebox is a digital device. The music content gets sent to it encoded as a computer file and gets decoded into another digital format known as PCM, Pulse-Code Modulation.
You can't hear PCM. You need an analog signal which speakers can actually use. The component necessary to perform this conversion from PCM digital to analog is known as a DAC, Digital-to-Analog Converter.
The Squeezebox contains a DAC which you can use if you connect the analog left/right connections to your equipment.
However you can also use your own DAC if you connect the Squeezebox's coaxial digital or optical digital outputs to your equipment as these outputs are internally connected before the Squeezebox DAC. DACs are available for use in some bookshelf/compact stereo systems, some computer speaker systems, some amplified monitor speakers, most A/V receivers, some preamps and as stand-alone units. You can identify such equipment by locating a coaxial digital or optical digital input. The Squeezebox's digital outputs are internally connected to a converter which converts the PCM signal to one suitable for transmission over the several feet required to get to your own DAC. This signal is known as S/PDIF for "Sony/Philips Digital Interface Format" and for most consumer equipment, will be in either coaxial or optical forms.
What Sounds Better, Analog or Digital?
The Squeezebox2 and Squeezebox v3 have a well-regarded DAC which is probably only equalled by a separate outboard DAC. It is at least as good as the DACs found in many A/V receivers. Note that A/V receivers are a special case as many will convert an incoming analog signal to digital then back to analog again which may degrade the sound, see here.
It's best to experiment as everyone's tastes are different. Some analog setups may produce a 'warm' sound (muted treble but possibly muffled). Some digital setups using a separate DAC may produce a 'bright' sound (emphasized treble, good clarity but harsh to the ears). Your situation may be in between these extremes. Let your ears be the judge of what's best for you.