[kmort]

[e-mail] and [e-mail] yield the same background colour. Isn't the point of this to detect accidental transpositions? You may want to use a simple hash in your algorithm.

The input field may need some explanatory text to alleviate the user's astonishment as to why the field is cycling colours in the first place -- it's a very unusual UI quirk.

Also, I suspect your colour palette is not friendly to the colour blind.

Edit: This is reminiscent of Lotus Notes' password hieroglyphics and Chroma-Hash: http://foxxtrot.github.com/Chroma-Hash/. The latter has been discussed on HN several times.