It looks like Xbox may soon allow you to set a custom picture as your Xbox Live avatar soon. According to Major Nelson, Microsoft is currently testing a feature to allow users to set their own custom pictures as their profile pictures, and it is set to roll out for at least some users soon, with Major Nelson promising that ‘select insiders’ will be able to test it out soon.
This is a feature that so far, other consoles have not yet allowed- Sony does let you set a custom ‘profile picture’ on PSN, but that becomes tied to your Real Name, and is only visible to those who can also see your real name. Your PSN icon remains one of the preset ones that you choose.
If Microsoft were to do this, they would be the first ones to allow something like this- of course, however, the question of how this would all be policed, and how they would ensure that no one puts up something inappropriate as their profile picture, is one that remains to be seen.