If you’ve ever made any tweak to your Windows Phone, you’ve probably used a cabinet (CAB) file to do so. Well, starting in Windows Phone 7, CABs will be no more. Instead, there will be XAP files. User Da_G from XDA goes on to explain…
A .xap is a simple, every day .zip file, renamed to .xap. Inside, it contains the app and all relevant dependencies. There are a number of possible .xml files that could be included inside the .xap to determine things like required security access level, to tell the system which .dll contains the main() for the application, etc.
I believe the .zip also provides a container for the virtual filesystem available to the app (not sure on that, it may be stored in a separate container, have to analyze more)
At least initially, .xaps will only be available for deployment through the Marketplace.