A corruption of the word "Owned." This originated in an online game called Warcraft, where a map designer misspelled "owned." When the computer beat a player, it was supposed to say, so-and-so "has been owned."
Instead, it said, so-and-so "has been pwned."
It basically means "to own" or to be dominated by an opponent or situation, especially by some god-like or computer-like force. "Man, I rock at my job, but I still got a bad evaluation. I was pwned."
What an explanation! I thought it was a fancy cross of pissed and on .
Well, the first time I saw it that is what I thought too. And that is how it started, just a typo and for whatever reason became popular (not with me but apparenly a lot of people think it is way cool).