Unlike iPhone, iPod touch does not have a GPS chip. But, it can still estimate your location. Your current location is used in map apps, including Google Maps. If you've used an iPod touch, you've probably tapped the location icon in Google Maps to zoom right into your whereabouts on the map (well, at least within a couple hundred feet).
Instead of GPS or cell towers, iPod touch uses the Skyhook Wi-Fi Positioning System. Skyhook's location services work indoors, which can't be said for GPS, which usually needs line-of-sight with the sky. In fact, iPhone also uses Skyhook's services in combination with cell tower signals and GPS so that your device can locate you just about anywhere.
Skyhook has referenced over 50 million Wi-Fi access points in the United States and Canada. Currently that covers about 70% of population centers. Skyhook continues to add the locations of Wi-Fi access points to expand its reach and improve its precision.
You can add the locations of Wi-Fi access points to Skyhook's database to make it even more inclusive and accurate. Let's say that iPod touch doesn't accurately report your location when you are at home (or says that your location cannot be found). Go to Skyhook's Submit a Wi-Fi Access Point page and place a pin on the map with your home's precise location. You'll also have to provide your Wi-Fi router's MAC Address (this has nothing to do with Macintosh computers, by the way) and your email address. After up to 7 days, Skyhook's databases are updated so iPod touches and iPhones near your access point can triangular their current locations more precisely.
If it seems iPod touch isn't giving accurate locations when at other places, say at school or at favorite hotspot, you can submit other access points to Skyhook as well--you'll just have to be able to provide Skyhook with the MAC Addresses. Follow instructions on this page to determine an access point's MAC Address.
Even without a GPS chip, iPod touch can triangulate its current location thanks to those millions of Wi-Fi routers that are registered with Skyhook. Submitting your router and other routers improves Skyhook's positioning services for everyone.