Modes

The 2G Nano has two special modes that it can boot into called disk mode and DFU mode

Disk mode

Disk mode has existed ever since the iPod has existed. Disk mode is stored in the 1MB NOR auxillary flash (along with the bootloader), so this is pretty much always there, no matter what sort of tampering you have done. Disk mode basically makes the iPod behave as a massive storage device, allowing the computer to directly read and write the data flash chip.

DFU mode

DFU mode is a relatively new standard for upgrading firmware that is used in many devices like the OpenMoko and the newer iPods. DFU mode (since nano 3G) is probably contained in the on-processor's bootrom. Newer iPods have both DFU mode and disk mode, while iPod Touch and iPhones have exclusively DFU mode. It is worth noting that DFU mode was implemented at the exact time that Apple switched from PortalPlayer to Samsung processors, and also exactly when the firmware was encrypted. There could be a relationship.

The nano 2G also has a DFU mode, but that one is probably booted of the NOR flash instead of mask ROM, and doesn't seem to have anything in common with the newer DFU modes. It is not yet found out how to communicate with a nano 2G in DFU mode, not even iTunes can do that.

Helpful pages

http://daniel.haxx.se/blog/2008/09/03/dfu-mode-on-2nd-gen-nanos/