And can understand hacker gibberish, go here. Evidently, some people just want to be able to use the iPod and WIFI capability and don’t really want to us it as a phone.
AT&T says that it is necessary to activate the phone for optimum performance (well, yeah):

AT&T spokesman Mark Siegel said it was necessary to activate the iPhone on AT&T’s network to ensure optimum performance. Using the phone without AT&T’s two-year service contract was unauthorized under the phone carrier’s exclusive network service contract with Apple, Siegel added.
“Any other use of the device is not authorized and we can’t guarantee the device will perform as intended to. We’ll monitor situations like this and if necessary we will take appropriate action,” he said. “Our terms and conditions are very clear.”

Do you have to show them some kind of id to purchase the iPhone? Do you have to sign a service contract before you purchase it? How would they know otherwise?
BTW, if you want WIFI access, a MP3 player, video, and the ability to view your photos, why not just get a Palm TX? It’s a couple hundred dollars cheaper and it uses SD cards, unlike the iPhone.