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The question says it. I am really wondering what it EXACTLY does, because I am getting from everywhere different answers.

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Sharepoint 2010 has introduced the new concept of "managed accounts" - basically, it stores the encrypted credentials for whatever service accounts you specify.

Initially, the passphrase is used to encrypt the credentials for storage. When you want to do things such as add a new server to the farm (from the server itself via powershell) you will be prompted for the passphrase instead of for the username/password as in the past.

The whole concept of managed accounts allows the passwords to be changed in AD without having to change the password everywhere the account is used in SharePoint. The complexity of changing the password in the past typically meant that the SharePoint service accounts were exempt from enterprise password change policies (which is a bad thing). Managed accounts mostly alleviates this problem, and can even go so far as to automatically change the password for you before it would expire due to policy.

Here is the technet overview of the managed password feature (which the passphrase is used for...)

http://technet.microsoft.com/en-us/library/ee428296.aspx

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