The xbox 360 is not water cooled in the way PCs are water cooled.
The xbox 360 uses heat pipe that is full of purified liquid, water or other wise. This liquid is sealed in something similar to a heatsink called a heat pipe (I think).
This is placed over the CPU cores and when heated the liquid evaporates until is condenses and cools at the top of the heat pipe. It then falls back down onto the CPU side of the heat pipe where it absorbs more heat.
This is a very effective way of cooling and continues until the CPU side is equal in temperature to outer side, which is usually room temperature.
This method of cooling DOES NOT require to be refilled as the heat pipe is sealed and does not require you xbox 360 to be on - it will continue to cool even when your console is off.
In addition to the heat pipe there are also dual fans, one in, one out. They are controlled independently to adjust air flow and also change due to the oriantation of the console.
When DVD playback is commenced, two of the three CPU cores are turned off to make the xbox cooler and in turn quieter as less cooling is required.
