Apple made a clever user interface change with iPhone 2.0:
When you enter text into a password field, it briefly displays the character you just entered. After a few seconds, it changes the character into the mask, but it gives you some visible feedback that you’re entering the characters you think you’re entering. (I always had problems entering passwords correctly until this feature was added.)
It’s an acknowledgement that entering text using a virtual keyboard isn’t foolproof, and it provides a good compromise between masking passwords so people can’t see your password over your shoulder and enabling users to avoid typos when entering them.
By the way, this screen shot was taken using the new screen capture feature in iPhone 2.0.
Update: Commenters have noted that other phone makers have been doing it this way for years. I guess what this really means is that the iPhone is the first phone that I’ve ever used to enter a password.