In a letter from Xbox Live's Marc Whitten, the Xbox Team announced changes to the Xbox Live code of conduct today that allow all gamers to freely express "race, nationality, religion and sexual orientation in Gamertags and profiles."
Previously, Xbox Live policy forbade the expression of sexual orientation, race, or explicit nationality (think awkward jingoist Gamertags like "Mao4evar"). The policy was meant to protect gamers from slurs or harassment, but the Xbox Team admitted that the policy actually wound up alienating some of its audience instead of protecting them.
The issue was discussed at length last year in a Gay and Lesbian Alliance Against Defamation (GLAAD) panel. Xbox Director of Policy and Enforcement Stephen Toulouse acknowledged during the panel that expressions of sexuality were as much part of our identity as, say, our favorite color or choice of avatar.
The Whitten letter concludes:
"I truly believe that our diversity is what makes us strong: diversity in gaming and entertainment options, and diversity in the people that make up this amazing community. I look forward to seeing you on LIVE soon."
You can find the updated code of conduct here.