wipe = factory DATA reset. sometimes referred to as a "hard reset." If you're rooted, it should be done from the custom recovery. If you're not rooted, it can be done under Settings > SD & Phone storage > Factory data reset.
It's not a format. It wipes all user apps and data. Your android version will remain the same. The core ROM is still intact. So this is not a factory reset. it doesn't put your phone in the state it came in. In other words, if you've upgraded to 2.2, a factory data reset will not put you back at 2.1.