Windows XP comes un-activated. In this state, Windows XP will only work for 30 or 90 days, depending upon your license. Product Activation is MANDATORY! If you want your system to work past the 30 or 90 days, you MUST activate your version of Windows XP.
When you activate Windows XP, a listing of your computer's hardware is encoded into a hexidecimal code along with your CD key and then sent to Microsoft. Once Microsoft receives that hexidecimal code, Microsoft sends back another hexidecimal code to activate Windows.
After this step, your CD key and computer hardware are now tied together. You now can't install Windows XP with the same CD key on another computer. Meaning, don't activate your version of Windows XP until you are sure you want to keep Windows XP on that system and that system only with that particular CD key.
Microsoft allows for 3 or 4 hardware changes without a re-activation. If you change your hardware so drastically that Windows XP doesn't recognize your system anymore, you must call Microsoft. When you call Microsoft, you will have to tell the representative what you did, tell the representative the code that Windows XP provides, and then the representative will give you a new activation code.
You can read up on Product Activation here.