Are you planning to sell your iPod, or do you just want to erase it completely to make it clean? This article will tell you how to restore iPod to its original factory settings.
Steps

Step 1. Make sure you have the newest version of iTunes
As of this writing, the newest version is 10 (10.2.1. For Mac). You can download the newest version from the Apple website.

Step 2. Connect your iPod to your computer through whatever type of connection you use (USB, firewire, etc)

Step 3. Open iTunes

Step 4. Click on the bar next to it that says "Your iPod's Name."

Step 5. Click on the top where it says “Summary”

Step 6. Click on the button that says “Reset”

Step 7. Select “Use Newer Version” when the window to reset the options appears
This will reset your iPod with the newest software available.

Step 8. Wait for the computer to reset the iPod
Advice
Make sure your computer can stay on during the formatting time, especially if you have a high-capacity iPod or have a lot of songs
Warnings
- This procedure will erase everything from your iPod. Think twice before doing it.
- Obviously, you should not disconnect the cable when it says the message "Do not disconnect" on the iPod. That could damage the software / firmware that is being updated.
- With older iPods you will need a wall socket, otherwise you will not be able to complete the process.