What is the best way to stream our band practices on uStream? Right now we are just using the microphone that came with our webcam.
What is the next step in improving the audio quality of our stream?
The next step would be mic'ing up your entire band through one mixing console, like you would for a live show, and running a stereo mix out of the console and in to your computer via a line in on a sound card and streaming that mix.
You wouldn't necessarily need a full-on dedicated mixing console to achieve this. You might be able to get away with something like a Presonus FireStudio -- where you've got an audio interface without enough mic pres and inputs to handle your bands needs. If you lay out the band (instrumentation, vocals, etc.) I could give you a more detailed answer on how you'd want to mic it for mixing.
Buy a Zoom H1 and run a line out into your laptop and then change the zoom H1 to your default mic.
Presto - killer sound
In the past I have done some recording of my band (keyboard, vocals, bass, and drums) using only 1 microphone between the drums and the bass and keyboard/vocal amp. I was able to get a pretty good mix by moving the microphone and speakers around until the sound was fairly well balanced.
You should be able to get a really nice jump in quality without too much cost by simply adding a decent USB mic to the computer.
The next step up in cost is to add a USB interface with 1 or more inputs, which would allow you to plug some of the instruments in directly.
To get maximum control over the mix you will need to go with a mixer or multichannel USB or Firewire audio interface and plug in as many instruments/mics as you can in directly. Every additional microphone and direct input you add to the mix will give you more control over the sound.
For more information on choosing a microphone to start with, see this question.