The Squeezebox Touch is a separate music server box that gets the files from you Netbook over a network connection. You use the Touch as you music system and user interface. The other option is to have a software Player running directly on your Netbook, which is what I do.
I use a Netbook for my source (Gateway) and it works fine. Since you already have a nice USB DAC, all you need is a USB cable between the Netbook and the DAC, which you may already be using for Internet radio. For a USB cable, you can start with any cable you have, although like all audio, you can also spend a lot on USB cables. But a simple one will get you going.
I would suggest Windows 7 Starter over XP, but you can certainly start with XP. Windows 7 has a better audio subsystem than XP. If you go to Windows 7, I would suggest Starter rather than Home unless you need some of the Home components for other things. The fewer the number of processes running, the better the sound can be. Although I am not sure if you can upgrade to Starter, or if it has to come installed. For a start, you can certainly use XP.
For ripping, most playback software has ripping capability. For the best ripping, the stand alone program dBpoweramp is a great choice. It not only rips damaged disks very well but also compares you rip to those of others so you can be sure all the bits are correct. Personally, I would rip to FLAC. It is a compressed version of the track, but is still lossless. Think about as zipping a file to save space. Some people believe that WAV files sound better, but that is a very active debate. FLAC will save you something like 40% in disk space. With WAV, the tags (artist, title, album title, etc.) have to be stored separately from the data. With FLAC, the tags are stored in the same file as the data. This makes it much easier to move the files around from system to system.
For playback, I like J River Media Center. It is a very full functioned player will very good sound quality. It does take a little getting used to, but you can use it just as it comes with very good results. It also will rip for you. I use it to rip unless I have a disk that is damaged, then I use dBpoweramp. JRMC is much more full functioned than Windows Media Player. JRMC also has a app that runs on Andoid phones (not iPhones) that lets you control the player from your phone.
Your DAC has an asynchronous USB connection which really helps keep jitter at a low level. So, with JRMC you can use Wasapi Event Style or Kernal Streaming, which will give you very good results. That is easy to set up with JRMC.
For drives, you an get 200+ CDs into about 50GB to 75GB using FLAC. If you have that kind of space on your Netbook, you could just start with that. You would eventually like to be able to back it up which you can do using a USB drive or even over a wireless network if you have a larger desktop system available. If you have a lot of CDs, a USB drive is the way to go. But you could get started with you Netbook disk if you have some space. I just use my Netbook drive, although it is a 250GB drive.
I would suggest trying J River. It costs $50 but it comes with a free 30 day trial. Load up the software, rip a few disks and give it a try. They have a forum that can help you if you have any problems, or I would be happy to help get you going. That would also allow you to easily compare the sound to your existing transport. The comparison will cost nothing but a little bit of your time.
I am 64 and use my Netbook for all my digital music. It replaced a Classe CDP-10, which is a pretty good CD player, and the PC sounds at least as good, if not better. And you already have a very nice DAC. I actually have an old MF A3-24 DAC feeding Cary SLP-05 pre, Levinson 432 amp and Sonus Faber Cremona speakers.
