The iPhone uses [assisted GPS](http://en.wikipedia.org/wiki/Assisted_GPS) to improve the accuracy of the location system using GPS and cell towers. Wi-Fi networks are used to help determine the device's location; this is called a **[hybrid positioning system](http://en.wikipedia.org/wiki/Hybrid_positioning_system)**.

In particular, iOS taps into (and helps to update) the [Skyhook Wireless](http://www.skyhookwireless.com/) **database of Wi-Fi hotspots and their locations**. You can even [submit new access point locations](http://www.skyhookwireless.com/howitworks/submit_ap.php) through their website to help improve the database (but your device will automatically upload information to keep this database fresh).

Here's [an article from Apple](http://support.apple.com/kb/HT4995) with more detailed information on iOS 5 location services. They also mention that Wi-Fi + GPS are used to crowd-source **traffic information**.

> If Location Services is on, your device will periodically send the geo-tagged locations of nearby Wi-Fi hotspots and cell towers in an anonymous and encrypted form to Apple, to augment the crowd-sourced database of Wi-Fi hotspot and cell tower locations. In addition, if you are traveling (for example, in a car) and Location Services is on, a GPS-enabled iOS device will also periodically send GPS locations and travel speed information in an anonymous and encrypted form to Apple, to be used for building up a crowd-sourced road traffic database. The crowd-sourced location data gathered by Apple does not personally identify you.

For your security concerns, read [this Apple press release](http://www.apple.com/pr/library/2011/04/27Apple-Q-A-on-Location-Data.html).