Wild speculation makes the front page? They probably put in a hardware block encryptor, which is generally useful for encryption (look up Secure Virtual Memory in Mac OS X). Yes, it is faster to wipe a block key than to wipe an entire flash drive, but this post should have ended there instead of speculating that Apple's engineers don't understand encryption.

If you like wild speculation, it is likely that the block key is large enough to provide adequate security, and that it is stored locally but encrypted with a data encryption method like RSA. The password for this might be as simple as a 4 digit pin, but thats irrelevant because the encrypted encryption key would be the first data wiped in the event of a data breech. If you're really paranoid, you could store a larger key on the network. Rebooting the device would then require network access, but it protects you against someone removing your compact flash and reading it directly.

Obviously backup files are not encrypted, or they wouldn't be very useful. If they are encrypted, it will only be as strong as the user specified password, or key stored on MobileMe.