I always install to the hard drive, you only need the disc in the drive to authenticate and it never causes a problem for me (no materr how damaged the disc is).
I've had it installed ever since it started doing this (2 or so months ago.) and it won't launch, instead it will give me a mixed media/unrecognized disc error, infinitely try to read the disc, launch and give me an unreadable disc error, or launch and kick me off of Xbox LIVE.
