GPS. The US Department of Defense has built and deployed a number of Medium Earth Orbit satellites. These units emit microwave signals that your iPhone will be able to detect and use to triangulate your position to extremely close proximity.
GPS capabilities are nothing new to smart phones but the iPhone provides a great match between the technology and simple third party application development with Apple's well publicized Core Location library. Look for third party apps to support all kind of tagging and tracking features.
When outside, with a clear signal (no trees or tall buildings) GPS can locate you to within a few feet of your true location.
WiFi Positioning. SkyHook Wireless offers extremely accurate WiFi positioning. The iPhone or iPod touch scans local WiFi and WiMax routers in your area and uses their MAC addresses to search SkyHook's databases to position you from that data.
This works great when WiFi routers stay still. This works terribly when people pack up their WiFi routers and move with them to, say, Kentucky. That having been said, SkyHook data does get updated.
It provides pretty accurate positioning and can usually locate you within a few hundred feet of your actual location, even though people and their routers will continue to move to Kentucky and other places. WiFi positioning can locate you to within a city block of your true position.
Cell Tower positioning Less accurate than WiFi location, Cell Tower triangulation figures out where you are by mapping Cell Tower locations. Cell Towers, which never pack up and move to Kentucky, provide stable guidepoints located every few miles.
Although the iPhone prefers to use WiFi and GPS when available, Cell Towers provide a pretty good fallback -- usually locating you to within a half mile or so of your true location.
IP Location. To be fair, let me just say that I have never once seen the iPhone actually use this method. Then again, I live in a major metropolitan area; I haven't given it a very good try. This last ditch approach uses IP location to find the nearest mapped Internet Provider's central office.
This is a solution of last resort. The returned data is typically up to several miles off your actual location-unless you happen to be visiting your IP that day.
As you can see, the iPhone uses a rich set of geopositioning tools. Skyhook tells me that the FindMe application I wrote for a TUAW reader a few months ago, which will now be replaced by the SDK's built-in Core Location, has already been used several million times. Between new location aware technology like social networking and tried-and-true favorites like Geocaching, the iPhone is poised at the forefront of a geopositioning revolution.