iPhone 2.0 Full Erase Contents & Settings
You must be running iPhone software v2.0 to use this feature.
To Determine which version of the iPhone software you are running..
1) On the iPhone, go to Settings, then select General.
2) Select About.
3) To the right of Version, if you iPhone's software version.
If you are running v1.1.4, you will need to connect your iPhone to iTunes and select "Check for Update". This will update your iPhone from the older software to the newer software. This will also allow you to take advantage of the Full Erase feature, which is not available in earlier versions of the software.
Why would you do a full erase, rather then a restore?
If you plan on selling your iPhone, whether it to a friend or on an online auction. We recommend you completely erase your data from the iPhone before doing so. The "Restore" option found in iTunes does not completely rid the iPhone of your data, it only covers up parts of the data. A technical savvy person could access your old data after a restore, therefor compromising your information security. Apple has implemented a low-level erase option that will allow a user to remove ALL of their personal data off the iPhone. "Data is never gone..." This is a true statement, but this erase option will remove your data to an acceptable standard.
On your iPhone running software version v2.0
Make sure your iPhone is plugged into a power source during this procedure!
1) Select Settings, then select General.
2) Then select, Reset.
3) You will be presented with many options, but the option for a full erase of the iPhone is "Erase All Content and Settings".
4) Select "Erase All Content and Settings"
4) A confirmation window will appear explaining that this procedure will erase the device of all of its media, data, settings, and will take about 1 hour to complete. Once this procedure starts, DO NOT try in disrupt or you may damage the iPhone.
5) Select Erase iPhone.
6) A second confirmation window will appear, again warning you that the data will be erased.
7) Select Erase iPhone.
8) The device will reboot and a status bar will appear. Allow the device to finish the erase procedure before removing it from its power source.
After the iPhone is done erasing, it's ready to be packed up and sold. (Or generously handed down 
)