Here is a very good tutorial that should help you: http://www.pyroelectro.com/tutorials/tachometer_rpm_arduino/hardware.html

Why use 4 pins if you can use only 2?
This is probably what you're looking for: http://playground.arduino.cc/Main/I2CPortExpanderAndKeypads

If you could develop position control for BLDC I'm sure you would find some interest in the CNC and 3d printer communities.

I agree, doing it all with an Arduino would probably be easiest. Although I haven't built it yet my next project will be based on this: http://www.pyroelectro.com/tutorials/tachometer_rpm_arduino/hardware.html

That driver board uses step and direction signals which is the standard for stepper drivers. The AccelStepper library can provide these: http://www.airspayce.com/mikem/arduino/AccelStepper/.
Building high power stepper drivers is not an easy subject. I would reccomend using a commercially available driver and saving yourself a lot of grief. A good selection of affordable drivers can be found here: http://www.automationtechnologiesinc.com/products-page/kl-stepper-drivers.
But I have to wonder why you would want to use an Arduino to control a CNC machine when you can have a full featured control program for free. I use LinuxCNC for my machine: http://linuxcnc.org/. I run it on a hand-me-down P4 computer and it's great. But if you're intent on a minituarized solution there are a number of people working on a version for the Beagle board and Raspberry Pi. I've been told a ready to run distribution will be ready in a matter of weeks.

  It sounds like what you are trying to do is build a lathe with "live" tooling whereby the workpiece revolves slowly and is cut with a milling cutter. A stepper motor can indeed accomplish this though you will likely need to gear it down via timing belts to get sufficient resolution. I would go to http://cnczone.com/forums/forum.php. It's a very large site and can be intimidating at first but you will find all you need to know there.

You could gear your encoder with a timing belt and pulleys to achieve a higher resolution.

Most current companies are trying to sell virtually limitless goods, in a system which is designed to deal with scarce goods. Forcing law suits on a bunch of individuals will never solve that problem - the only way to solve the problem is by changing the market strategy. Slowly people are catching on to that.)

Amen, brother!

He's not from the US, he's from Texas! 

I know what resin is!   smiley-eek (Amsterdam is just over the water smiley-evil)

Lucky you! LOL
Rosin is the flux inside of the the solder. It helps the solder flow and stick to the intended surface but it also can cause corrosion if it is not removed.

Does anyone want to confirm for me that the black marks are because of no heat control on my iron then I will rest easy!

It looks to me like the black marks are just rosin. It can be easily removed with some rubbing alcohol and an old toothbrush. A temperature controlled iron is nice to have but a simple iron can give good results with proper technique.

Glad to hear Australia has such consumer protection laws. Corporations in the US handily hide behind license "agreements" that can't be read until the package is opened and not returnable and even if one does read them cannot be deciphered without the help of an attorney. Unfortunately this tactic is not limited to games but is also a feature of credit agreements, insurance policies and many other products of more vital importance than games. Caveat emptor is a useful principle but only when transparency exists. But the "free market" proselytizers seem to always resist such transparency.
Perhaps if we spent less time playing games and more time examining the realities of the current system we would choose lawmakers that work to create a more fair playing field. Intellectual property laws have become entirely perverted and need to be changed. The concept of "corporate personhood" ensures they won't.
I embrace the opensource movement because it exists as an alternative to corporate control and I see it as one of the few bright spots in our future.

Paul is right, you need to supply more information on the drive. Unlike stepper drives which almost universally take step and direction signals, servo drives vary greatly. Some take step and direction, analog (usually +/- 10V), or serial commands that set position, velocity, or torque or various combinations of the above. Others have proprietary schemes that will only operate with the manufacturers controllers. So it may be very easy or nearly impossible depending on the drive.

A dedicated stepper driver generally uses step and direction signals (2 wires vs. 4 required). The driver also handles microstepping and current control. More advanced drivers have features that limit motor resonance, etc. All of these are necessary for critical motion control applications such as CNC.

That's a good question but I think PWM wouldn't be the dominant method of controlling DC motors if there was a significant downside.
I'm not certain (maybe someone can comment knowledgeably on this) but my understanding is that the inductance of the motor coils smooths the PWM square wave so what the motor sees is pretty much a DC current with some amount of ripple.