The three-step process is normal. I've seen it described in a number of articles. For whatever reason, the Time Machine encryption is not done by simply creating an encrypted external drive the way you would with Disk Utility and copying the data. It does seem slower than it should be in your case however. I had about 105 Gigs on my new Air and the third step completed overnight for me, less than 7 or 8 hours. I can't be sure of the exact time it took since I wasn't up to watch it finish. It seems like based on this yours should be more like 75 % complete in 12 hours. It may be that the percentage progress indicator is not accurate. It is also possible that it depends on the amount of free space on the time machine drive. How big is your USB drive?
The only comfort I can offer is that once it's done, the routine backups proceed just as fast as ever. It doesn't seem like the encryption makes any difference in performance once it is completed.
Steve, thank you for your reply. The drive is 1 T, with two partitions. The partition on which this Time Machine backup is being placed is 750 Gigs and has nothing on it other than the Time Machine backup, which was initiated immediately after the partitioning process finished.
A somewhat related point -- my initial plan was to first create an encrypted external drive using DiskUtility, and then enable a Time Machine backup onto that drive. I discovered that DiskUtility crashes when you ask it to complete an Erase command and you choose one of the encryption options in the pull down tab for which format you want. I replicated this crash on 2 different 10.7.1 MacBookPros and on a MacBook Air, and told Apple Support about it, they have escalated it to senior people who promised to get back to me.
Since Time Machine says it is setting up the drive for encryption before it actually starts the backup process, it occured to me that a workaround for DiskUtility crashing would be to start an encrypted Time Machine backup on a freshly partitioned drive, then stop it after the "setting up encryption" process ended but before the actual backup started. I tried this on another drive and it seems to work in that in order to mount the drive, you are prompted for a password.