Personal Hotspot is a feature of iOS 4.3 and higher that lets an iPhone share its wireless data connection with other nearby devices via WiFi, Bluetooth, or USB. In that scenario, the iPhone acts like a wireless router for the other devices, transmitting and receiving data for them. An iPhone 4 or higher is required for WiFi connections, though an iPhone 3GS can offer Bluetooth and USB connections.
Using a Personal Hotspot is pretty easy once you've got it set up. It requires an iPhone with an active data plan, as well as the tethering option added to that plan.
To begin setting up your Personal Hotspot, tap on the Settings icon on your homescreen (unless you've moved it elsewhere; if so, locate it there and tap on it). Then tap on General. Then tap Network.