Whereas most games consoles to that point were built from custom hardware components, the Xbox was built around standard personal computer components, using variations of Microsoft Windows and DirectX as its operating system to support games and media playback, and featuring a 733 MHz Intel Pentium III CPU and a 233 MHz Nvidia GeForce 3-based NV2A GPU, the latter two making the Xbox technically more powerful compared to its rivals.

Before the Xbox, Microsoft had found success publishing video games for its Windows PCs, releasing popular titles such as Microsoft Flight Simulator and the massively successful Age of Empires after the creation of DirectX, the application programming interface (API) that allowed for direct access of the computer hardware and bypassing Windows.

Sony was working on its next video game console, the PlayStation 2 (PS2), announced officially to the public on March 2, 1999, and intended for the system to act as a gateway for all types of home entertainment.

Additionally, Gates had directly approached Sony CEO Nobuyuki Idei before the public announcement of the PS2 regarding letting Microsoft develop programming software for the console.

Microsoft executive Craig Mundie wanted the project to be led by the WebTV team, who believed the console should be built from the ground-up as an appliance running off Windows CE; however, the DirectX team were adamant about the idea of repurposing PC hardware components, such as a hard disk drive, arguing that they were cheaply manufactured and could easily be updated every year.

The 4 developers gained the support of Ed Fries, the head of Microsoft's gaming division, who believed the use of a hard drive, in particular, would give the console a technical edge among competitors despite its high manufacturing cost.

WebTV's team, among whom were Nick Baker, Dave Riola, Steve Perlman, and Tim Bucher, and their sponsor, Craig Mundie, made the case that creating an appliance would be far cheaper, highlighting that most consoles were generally sold at around $300.

Conversely, Fries, vouching for the DirectX team, argued that using a PC hard drive would set Microsoft's console apart from competitors by allowing for the direct implementation of online access, an argument which Gates sided with.

When Gates questioned if PC games could be effectively ported to the new console, Blackley explained that the machine would utilize DirectX hardware, meaning that they could be converted easily.

While Thompson and Bach had warned Gates and Steve Ballmer about these large-scale changes from the initial proposal in late 1999, the matter came to a head at a February 14, 2000, meeting, informally referred to as the Valentine's Day Massacre, in which Gates furiously vented about the new cost proposal and massive changes in this console from what had been previously presented, since the Xbox appeared to marginalize Windows.

At one point, Hase jokingly came up with the names "XXX-Box" and "DirectXXX-Box" as a nod to the system's higher volume of adult content compared to Sony or Nintendo's consoles.

[25] Gates first publicly mentioned the Xbox in an interview in late 1999, stating that he wanted the system "to be the platform of choice for the best and most creative game developers in the world".

[40] It was later announced officially by Gates in a keynote presentation at the Game Developers Conference in San Jose on March 10, 2000, showing off an early prototype build of the system and a series of demos showcasing its hardware.

[44] Microsoft began acquiring a number of studios to add to the division, notably Bungie in June 2000, shortly after their announcement of Halo: Combat Evolved.

[45][42] The Xbox was officially unveiled to the public by Gates and guest professional wrestler Dwayne "The Rock" Johnson at CES 2001 in Las Vegas on January 3, 2001.

The Xbox includes a standard AV cable which provides composite video and monaural or stereo audio to TVs equipped with RCA inputs.

With bandwidth limitations, it has a realistic fillrate of 250–700 megapixels/second, with Z-buffering, fogging, alpha blending, and texture mapping,[59] giving it a real-world performance of 7.8–21 million 32-pixel triangles/second.

[76] Although the console gained strong third-party support from its inception, many early Xbox games did not fully use its powerful hardware until a full year after its release.

[77] Sega released exclusives such as Panzer Dragoon Orta and Jet Set Radio Future, which met with a strong reception among critics.

[80] The Xbox Live online service was launched in late 2002 alongside pilot titles MotoGP, MechAssault and Tom Clancy's Ghost Recon.

Several best-selling and critically acclaimed titles for the Xbox soon followed, such as Tom Clancy's Splinter Cell, and Star Wars: Knights of the Old Republic.

Take-Two Interactive's exclusivity deal with Sony was amended to allow Grand Theft Auto III and its sequels to be published for the Xbox.

[15] Services were discontinued on schedule, but a group of users later known as the "Noble 14" continued to play for almost a month afterwards by simply leaving their consoles on connected to Halo 2.

With its initial retail price of $299, Microsoft lost about $125 for every system sold, which cost $425 to manufacture, meaning that the company would have to rely on software sales in order to make any money.

[30][31][97] Microsoft also struggled to compete with Sony's more popular PlayStation 2 console, which generally saw far higher sales numbers,[98][99] although the Xbox outsold the PS2 in the U.S. in April 2004.

[25] Prior to its Japanese launch in February 2002, many analysts estimated that the Xbox would have trouble competing with the PS2 and the GameCube, its local counterparts in the region, noting its comparatively high price tag, lack of exclusives, and larger size which would not fit as well in Japan's smaller living spaces.

[102] For the week ending April 14, 2002, the Xbox sold only 1,800 units, considerably less than the PS2 and GameCube, and failed to see a single title reach the top 50 best-selling video games in Japan.

[108] Factors believed to have contributed to the console's poor market presence included its large physical size, which contrasted the country's emphasis on more compact designs, and a lack of Japanese-developed games to aid consumer interest.

The popularity of the Xbox, as well as (in the United States) its comparatively short 90-day warranty, inspired efforts to circumvent the built-in hardware and software security mechanisms, a practice known as "cracking".

Within a few months of its release the initial layer of security on the Xbox BIOS (which relied heavily on obfuscation) was broken by MIT student Andrew Huang and the contents of the "hidden" boot ROM embedded on the MCPx chip were extracted using some custom built hardware.