RF operates its own PBX, which you connect to over a web client. Once there, it finishes routing the call using VoIP and connects it to your iPhone handset. You use your iPhone calling plan minutes whether you're talking to a guy down the block or your buddy in Beijing.
Because their client is web-based, it works with 1.1.4 and earlier iPhones as well as 2.0 iPhones and later. All the heavy lifting happens at the RF servers, connecting you through the VoIP networks. RF's service is free and still extremely beta -- so be prepared for growing pains as they stabilize their software and roll it out. RF Founder/President Marcelo Rodriguez says they're planning on keeping the basic service free for the forseeable future. They are monetizing by reselling the service to VoIP service providers such as PhoneGnome and will be offering premium features at a later date.