Digital audio connections (sometimes called SPDIF - Sony/Philips Digital InterFace) allow a source to feed the unaltered digital audio signal (PCM stereo from CD's; PCM stereo or Dolby Digital from cable and satellite receivers; PCM stereo, Dolby Digital, or DTS from DVD's) to a receiver or processor so that the processor can work with the original digital data for signal processing and (in the case of Dllby Digital and DTS) decoding. This also allows you to have a single high quality DAC (digital-to-analog converter) or group of DAC's in the processor, so you don't have to worry with getting good DAC's in each source component. I'd recommend using digital audio connections wherever possible - the only places to use analog are sources that lack digital audio outputs (the SMS-1) or formats which do not allow digital output (SACD and DVD-Audio).

In my system, I've got one of the Blue jeans Belden 1694A coaxial digital audio cables along with three Outlaw PDO optical and one Outlaw PSC coaxial digital audio cable. Whether coaxial or optical is superior is a matter of some debate, with no conclusive answer that I've ever found. For longer runs, I'd definitely lean toward optical (light doesn't care about EM or RF interference, after all), but for the short runs you're probably looking at I don't think it really makes any difference.