The "guitar" is a series of lasers spaced out like guitar strings. There are eight lasers, one for each note in an octave. Simply input a music stream and the lasers light up synchronized to the notes in the music. Block the lit lasers with your hand to play the notes, which you hear through speakers.
See a demo here: http://www.youtube.com/watch?v=2jXdVuBmwm4. (In case you're wondering, the clapping sound in the video is someone clapping two chalkboard erasers together to release chalk dust into the box. The chalk dust illuminates the laser beam trails. There's also some background music playing all the time through the speakers.)
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Watching you play made made me realize how important pre-note-playing visual queues are in the console game. Have you considered building a couple second delay (understandably difficult: Tape Delay or Bucket Brigade ) into the system so you can light up an indicator LED before you actually have to play the note?