Chronology
The Motive
Understanding the mindset and motives behind Apple is key to understanding how and why the iPod was encrypted. While many people believe that the iPod was encrypted to put an end to iPodLinux and Rockbox, the main reason for the encryption was to thwart third-party imitators. Apple was not as concerned with iPodLinux and Rockbox because people were still buying their (overpriced) hardware, and therefore still generating profits. The main reason was because there were many imitations that replicated the hardware and ran the exact firmware that was run on normal iPods. This was a major drain of money for Apple. Another reason was that the DRM mechanism in the unencrypted firmware was being hacked. This allowed pirated content like games to be run without being bought.
The Response
Since Apple was losing money from the iPod imitators, they encrypted the firmware so the iPod clones could no longer use Apple firmware on their devices. There are still iPod clones out there (just search eBay), but very few use the Apple firmware anymore. Apple has encrypted all of their portable devices since the iPod Nano 2G.