What does ‘encryption’ mean for my iPhone and data?

The data on your iPhone is scrambled and the "key" to unscramble the data is the Passcode that you use to unlock your iPhone. If someone else takes your phone, they will not be able to view anything that is on your phone without providing the Passcode.

In addition, if they attempt to reset your iPhone, the device will be locked to your Apple ID/Password that you used to sign into your Account. This protects your device from ever being used by anyone else without being able to provide your credentials to remove the Activation Lock.

So the protection is two-fold:

• Data is protected with Passcode
• Device is protected with Apple ID/Password. This is true even if you remotely erased the data on your iPhone.

Above reply is correct.

Encryption replaces an A in your data with some other letter such as a B, and replaces a B with a C, and so on

(The actual encryption details used in iPhone are more complex, more robust, and much more secure than is this replacement example.)

Unless you know the pattern used to scramble the data — the key or passcode or password used to encrypt the data — that data is somewhere between exceedingly difficult and impossible to decrypt and access.

This encryption protects your data against unauthorized access.

Without the passcode or password, the data cannot be decrypted.

The decryption depends on the strength of your passcode or password. Longer is better, and secrecy is essential.

Face ID is handy here too, as that means needing to enter a longer (and therefore more robust) passcode or password less often. Face ID is not a replacement for a passcode or password, but it can avoid needing to enter the passcode or password quite as often.

If you want some more technical details about security: Apple Platform Security - Apple Support