the most likely answer would be to use GameKit, which communicates via bluetooth and can be used to discover other phones that are nearby. no wifi connection needed.

Or perhaps their server keeps track of GPS coordinates to know when two online players are in target range of each other?

having just now read the article, it appears they are using wifi to connect players. bluetooth isn't usable by third-party programs if you've got an original 2g iphone, so they've widened their target market a bit that way.

therefore, there's no need for gps. i suspect it wouldn't be accurate enough to do any good, even if you wanted to use it. there's no reason to determine whether a player is in range or not; the program knows which players are in the game from the very beginning.

also, i'm guessing that they don't use an internet server to mediate games. there's no real need for one, and eliminating that need means the game is less expensive to maintain.