Wiping Data with "Erase All Content and Settings"

If you use erase all content, it's like reformatting your hard drive. Everything is erased. Unless you have your SHSH blobs, you will be forced to upgrade to 4.1.2.
To determine if you have these blobs, go to the main Cydia screen or d/l Tiny Umbrella. On Cydia's main screen, look for SHSH or look at the log window in TU. If you don't see anything, you won't be able to erase your data, except via manual means. Your friend is correct that updating to iOS 4.2.1 will update your baseband. It is possible to unlock, but it is a very complicated process.
FYI: if you don't already have blobs, you should start saving them. Use Tiny Umbrella.

 

In 4.x, erase all content takes a long time. IIRC, its because it zeroes every piece of the flash storage out.

With a jailbroken phone, an erase all content will leave you with a dead phone, until you DFU restore, so think twice about the erase all unless you want 4.2.1 on your device.

If upgrading to 4.2.1 doesn't matter, I personally would do a DFU restore to 4.2.1, an erase all settings, then restore again. since the 4.x erase is a lot more thorough, you are essentially assured that none of your old data will be present on the phone.

 

If your friend needs the unlock don't restore it. Take all your data off manually. Then let your friend do what ever they want with the iPhone. The new 4.2.1 unlock/jailbreak is a little more complicated.