Lava

Lava is a substance found at approximately 1900-2300ft deep. If a player comes into contact with lava, it will deal 100 damage per tick to the player. Monsters (except worms, Man Eaters, Skeletron, and every monster in The Underworld) also take damage from lava, but only 50. Players under the effects of Obsidian Skin Potion are immune to lava damage.

Obsidian
Lava, with water, is the only way you can obtain obsidian, mixing (or touching) the two liquids will cause the creation of an obsidian block. This could be difficult due to the lack of water at -2100ft depths; Earthwelling is an effective way to harvest vast amounts of obsidian. Lava can also be transported via a bucket.

Properties
Lava functions the same as water, meaning you will lose air when submerged and require Flippers to swim effectively in it.

Items that are thrown in the lava are destroyed. Therefore, use caution when you are accessing your inventory near lava. Note that the midpoint of an item has to collide with lava for it to be destroyed, so shallow lava may not destroy items. This is a useful property to keep in mind for creating monster traps, as even a shallow layer will hurt a monster, but won't destroy the loot.

Trashcan
Because items in Terraria can never really be disposed of (just dropped on the floor), many players choose to have a small Lava pit in their house. By ditching unwanted items into the pit, players are guaranteed to never accidentally pick it back up. This effectively makes the Lava a Trashcan for items. However, blue items or higher will still not be destroyed. To counter this, a deeper lava pool is required to assure that the item will not be picked up again after dropped.

History
Since 1.0.5 lava will remove Grass (including Jungle Grass, Mushroom Grass, and Corruption) from dirt and mud blocks. As of 1.0.5, lava will also not destroy any item with a blue rarity or higher when coming in contact with any amount of lava. This was to prevent items such as the Sunfury from being destroyed after being dropped by a Bone Serpent.