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Yes, you must have dedicated HDD/SSD to install Euphony. It cannot include any other software/partitions. Euphony is first installed on USB by writing complete Euphony disk image to it. Later, when installing on chosen internal disk from euphony application this disk will be automatically formatted and partitioned (4 partitions) before restoring euphony operating system file structure to it.
Similar to USB requirements you need at least 8GB disk capacity for your permanent Euphony installation. If you are planning to use this disk for your music library then, of course, it should have a lot more capacity. If you already have a disk which contains your music files you can attach it too, either internally, via usb or via network. Most optimal is to have big SSD disk but Euphony employs several optimizations so your playback will not suffer no matter where the song files actually are: on slow disk, attached usb drive or network.
After Install, system partitions will take 8GB capacity, all the space left will be used for data partition where your music library can reside.