If you just want to restore original settings to the phone you will need to go into Settings \ General \ Reset on your iPod and then select "Reset All Settings". If you want to do a factory restore (return the iPod to the way it was out of the box) you will need to plug your iPod into your computer and load up iTunes. I would suggest doing a backup beforehand just in case. You can do this by right clicking on your iPod under devices and click on "Back Up".
After the back up completes highlight your device in the left-hand pane and select the summary tab. Click the "Restore" button and it will return your iPod to factory.
SOURCE: i cant restore my ipod touch
shut ipod off.....get the usb wire and connect it to the pc..(while connecting to usb to ipod hold the home buttun down).....ituntes shoud pop up in few seconds on pc.....click ok (aftter u have read the grey box)....now click restore.......done.............
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