Gen2 has side volume control buttons and built-in speaker (although that's not particularly useful for listening to music), plus chrome rear. I think it has a mic input also, can't remember...
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The ipod touch 2g has a number of advantages. The two that make the biggest difference for me are the volume buttons and the inbuilt bluetooth. It can communicate over bluetooth with stereo headphones - no wires! Also while there isn't a built-in microphone, the 3.5mm socket can take a microphone input so you can use it for Skype etc.
Great little device (although it's really making me want an iphone).
ooh I forgot the Bluetooth bit; I've just sold my 1gen and replacing with a 2gen, which I'm getting in a few days from a friend who has acquired an iPhone.
Does mean I need a different case though, for the shape/volume buttons