storage options for MacBook Air

Without knowing the type of player you plan to use it's tricky to suggest anything. 

Seems to me that the portable benefits of the MB Air are lost when it gets connected to a wired up external drive and DAC. 

Having you considered a streamer w/ internal storage? One that you could control with your MB Air or a phone/tablet?

Haven't considered anything else since this setup mainly includes pieces that I already have which is the MB Air running iTunes connected to a Ultra Fi DAC-41 USB DAC. My files are all AIFF which is why I'm sticking with iTunes.
The question remains, do I keep my music on the external drive or copy music to the solid state drive of the MacBook? 

When I had my MAC Book Pro, I stored all my music on an external  LaCie hard drive (used Thunderbolt cable) and not on the MAC Book Pro computer.   I never tested this but my retailer said playing music from an external hard drive would sound better then if the music was stored on the MAC Book Pro computer.  My LaCie hard drive was backed up to a 2nd hard drive.

I have since replaced my MAC Book Pro Computer with the Aurender N10 Music Server.   My audio system sounds more open, more natural, clearer, better bass and I am very happy I purchased the Aurender.  The ability to switch back and forth between Tidal music streaming and my stored albums on the Aurender is now a very easy process (one mouse click).  The Aurender iPAD app is much easier to use than my MAC Book Pro computer.  Album selection is also excellent with several different album selection choices available.  The Aurender N10 Music Sever is highly recommended for its great sound quality and ease of use. 

I also use the AIFF format. And iTunes.

So the answer depends on the number of albums/songs in your library and if you plan to add to it.

I assumed that the external drive was used because you were running out of disk space on the MB Air. Which, as your library grows, is gonna happen.

For example, my Rollings Stones "Let It Bleed" CD to AIFF rip is 455 Megabytes. Not sure how much overhead Mac OS (or OSX) uses on that MB Air. But if an album runs 450 Megabytes per CD you could calculate how much of your library it could hold. 

If you like iTunes (and I do though I use Roon for playback but hear no difference in SQ from iTunes) then maybe consider a MacMini to run iTunes and output to the Ultra Fi. You control the Mini iTunes from the MB Air using Screen Share. That existing external drive could be connected to the Mini.