Hi - thanks for the advice.
I did just that - started from scratch, re-flashed the Slug and un-slung the OS. Installed Twonky Beta 5 and... exactly the same thing happened! It wouldn't accept the password that I had only just created when unslinging..
I use a flash Drive in Disk 2 for the OS and a 300GB in Disk 1 for the audio files. When I unplugged Disk 1 the installation went fine and accepted my new password, no problem. Not sure if that's what supposed to happen but it worked for me