The ‘baseband’ is the generic name given to the internal components of the iPhone that handle the phone calls and Internet access. This ‘baseband’ is a tiny and unique independent computer system that runs inside your iPhone, it is separate to the main system that handles the applications (such as email and google maps) and it talks to the main part of the phone over an internal communications network. Think of it like a cable modem or other peripheral that is attached to your home PC that needs occasional updates. When a software update is released and presented to you within iTunes the baseband is sometimes updated (to fix bugs or add new features).

iPhone 3G Unlock

The 2.2 update for the iPhone 3G contains such an update, so running the vanilla updater straight away with iTunes will reprogram and update the baseband. This could be bad for certain people, depending on your ultimate aim.

special thanks to the iphone-dev team for this answer. It was straight off of their blog and probably couldn’t be stated better.