I'm not entirely familiar with C-Media-based cards like yours (X-Fi user here, and it doesn't help that the popular Asus Xonar line has a different control panel from the Auzentech and HT Omega offerings), but I can try and clear up some things:
-At some point in the chain, you HAVE to convert the digital sound signal to analog. Currently, this is done on the X-Meridian itself, though you can use its S/PDIF output to stream the digital data to an external DAC later on if desired.
-DSP effects can be confusing. For instance, with Creative cards, there are these EAX room modes that add reverb and other effects to any sound played through the system. You generally want these off, especially if you're playing games that have their own EAX presets for that sort of effect in the game environment, otherwise you end up with way too much reverberation.
-I see a Dolby Headphone button. That is a special DSP effect, a binaural surround filter. Very useful for 3D games, when you want to tell apart front and rear just like left and right using nothing more than a pair of competent stereo headphones. It should have three modes: DH1, DH2, and DH3, with DH2 and DH3 introducing increased amounts of reverb. The most popular mode seems to be DH2, enough to where external DAC/DSPs like the Astro Mixamp and Turtle Beach Ear Force DSS only use DH2. I suppose it's because the reverb is a distance cue that gives DH1 less of a sense of distance, while DH3 introduces far too much.