The XBox live integration on WP7 looks promising, but the avatars could be a bit more animated perhaps.
This is what the Aura project is trying to remedy. A collaboration between Carnegie Mellon university and Microsoft, the Aura project is aiming to make your avatar reflect what you are doing and reflecting your activities, be it from your calendar or social network updates.
Check out the video below.
The question is if this will be worked as an app on WP7, or if it actually will integrate with the other apps and programs. It would indeed be nice to see it, as in the demo, reflecting what you are doing based on for example your calendar info.
More info about the project can be found here.
3D Avatars on Windows Phone 7