Wipe an ipod touch

[BILKO1]

I've just bought a secondhand ipod touch, it's a gen3 8gb mc086bt (which means it's a gen2 with slight hardware upgrade)running ios 3.1.3. It is jailbroken untethered (not sure what program was used) and the shsh 4.0 to 4.2.1 are stored on cydias server. It came absolutely full of crap apps and music i don't want so i want to completely wipe it and start again maybe on a higher ios if it can be jailbroken untethered again. What is the best way to do this without cocking it up? I see there is an reset option in settings with various other options but will this delete cydia?

[DJAd]

A reset will wipe everything including cydia.

http://support.apple.com/kb/HT2110

[BILKO1]

What firmware can i go to and still be able to have an untethered jailbreak? Currently on 3.1.3(7E18) also do i download a 2g or 3g ipod touch firmware as it's an 8gb people say it's only a 2g with better software.