AFC is a service that runs on every iPhone / iPod, which iTunes uses to exchange files with the device. It is jailed to the directory /private/var/mobile/Media, which is on the second (non-OS) partition. The AFC service is handled by /usr/libexec/afcd, and runs over the usbmux protocol.
AFC2 is a an additional AFC service, configured to allow access to the whole filesystem. Installing it and patching the fstab file for full write access is considered a bare-bones jailbreak. The AFC2 service is added by editing the /System/Library/Lockdown/Services.plist file and adding a service that runs under root with access to /.