>How does this audio get sent over the WiFi does it get re encoded or is it sent RAW?
The AirPort Express Base Station (AX) works only with iTunes v4.6+ and is limited to music files that iTunes can read; ie, 16-bit data only. (An exception is you can use a third-party product like Rogue Amoeba's AirFoil to stream other non-iTunes sources.) These data, though, can be in any file format that iTunes recognizes, from lossy MP3s at the low-quality end of the spectrum to Apple Lossless and lossless AIF or WAV files at the high end. It is also important to note that the AX functions only at a 44.1kHz sample rate. When you play 32kHz or 48kHz data, iTunes sample-rate-converts the data in real time before sending it to the AX.
iTunes uses a QuickTime CODEC to convert audio files to Apple Lossless, and then, uses AirTunes to send them to the AX.
>What happens at the Express end, again is it just streamed RAW via the optical out or does it pass through a DAC first?
The AX uses built-in software that converts the Apple Lossless to an Encoded Digital Audio format. From there, digital audio is sent to a optical transceiver to convert the electrical signal to an optical one before sending it to the innermost part of the audio port. For analog, the AX has a built-in DAC to convert the Encoded Digital Audio to Analog which is sent to the same audio port.
>How doe the Express differ from the Apple TV 2, do they stream audio the same way or is one device better than the other in regards to audio.
The biggest difference between the AX and the Apple TV, when it comes to streaming, is that the Apple TV works with video & photos, in addition to audio ... whereas the AX is limited to audio only.
To the best of my knowledge (Apple has not released any details to confirm), the QuickTime encoded Apple Lossless audio is passed through either the AX or Apple TV's digital optical output port "untouched." Analog output from the AX would be converted by the AX's internal DAC. The Apple TV 2 does not have an analog audio output option.
I am fairly certain Apple TV 2 does not have a built in DAC. The original Apple TV did - to convert for the RCA analog out on the back. But the Apple TV 2 only has HDMI (digital) and optical (digital).
I think this is how Apple has saved money since it expects most consumer to have an AV receiver with optical or HDMI ports which in turn means the receiver has a DAC.
In my case, I have a perfectly fine stereo receiver with no HDMI or optical ports. So, for the Apple TV 2 I will have to by an external DAC (Toslink to RCA).
Thankfully Apple includes in the interface of the Apple TV 2 a way to turn Dolby Digital off. Otherwise, an external DAC would just make hissing sound from the speakers.
Side note: HDTV makers are leaving out DAC to RCA on lower end sets to cut costs (but make it a hassle for analog audiophiles). The ONLY HDTV in my price range with most of the features and size I wanted, was a Sony. But originally I had bought a Samsung with a much better picture and many more features but ONLY HDMI and Toslink out!
I’d buy a new receiver with all the newest stuff but it is not in my budget yet plus I have 4 Ω speakers - tricker to amplify and, the old one works fine.