iPhone 3G offers real GPS hardware, replacing its predecessor's simulated GPS, which was based on cell tower triangulation. Like many mobile handsets, iPhone 3G uses "Assisted GPS", in which it gets certain information, such as time and satellite orbital geometry, from the earth-bound network. Helped by this data, the device can more quickly locate and lock onto GPS satellites, resulting in better performance and less power usage.
The new iPhone software provides location services to applications (more on this below). The Camera application "geotags" photos with your GPS location (with your permission — it asks first!), and Google Maps can provide driving directions. Third-party apps are already using location services, including quite a few social networking applications. Apple has placed some restrictions on third party developers, however, and specifically prohibits live navigation software. It's not clear why this is, but even the Apple-blessed Google Maps application is limited. An accurate capacitive touch screen and well optimized mobile processors form the basis of that experience, but the iPhone continues to derive its real power in usability. But the touch screen keyboard can still be a major sticking point for some -- ourselves enthusiastically included -- and Apple hasn't given any more of its default programs (like SMS) the incryping that comes with using the keyboard in landscape mode.