It's the name you would use when someone asks you for the address of your web site; the "official" name. This would typically be something like www.example.com, and must be one of the aliases that is associated with your site (this can include the default alias ending in .nfshost.com).
The default canonical name of each site is its nfshost.com alias. If your site's shortname is example, then its default canonical name is example.nfshost.com.
Having a canonical name is especially important when you want to have a bunch of alternative names for the same site. For example, if your website is for Example, LLC, you might want to have www.example.com, www.examplecompany.com, and www.example.biz all point to the same site. You may even want to have www.awesome-widget.com for your awesome widget. Plus all those without the www in front. Knowing and setting one of those names to be the canonical name for your site and enabling canonical redirection can improve your search rankings.
We encourage (but do not require) you to use www.example.com as a canonical name rather than example.com in most cases. See this FAQ entry for an explanation.
For more information on aliases, see this FAQ entry.