AirDrop for iOS is similar to the OS X counterpart. It allows you to share files over WiFi1 to nearby devices, such as photos, contacts or Passbook passes/tickets.
The 'Contacts Only' setting requires that you be logged in to your iCloud account, and you must have the sending device's Apple ID in your contacts.
The receiving device must accept a share, similar to OS X. A popup notification will appear when someone attempts to send you something.
1 (however Bluetooth must be powered for the initial connection to begin - the device sends files through WiFi, however the secure connection handshake is achieved through Bluetooth)
Sending a photo or a document to someone via text or email is fine. But if that someone is right next to you, a text or an email suddenly feels like too many steps. Enter AirDrop for iOS. It lets you quickly and easily share photos, videos, contacts — and anything else from any app with a Share button. Just tap Share, then select the person you want to share with. AirDrop does the rest using Wi-Fi and Bluetooth. No setup required. And transfers are encrypted, so what you share is highly secure.