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I know the iPhone can and does use WiFi proximity to get approximate location. This obviously only can occur when some database in the sky knows the approximate location of that WiFi hotspot. My question is how do hotspots get into that db? Is it automatically added whenever the iPhone has a reasonably accurate GPS position and detects the WiFi or is there some manual or programatic way of adding hotspots?
Apple uses their own database since iOS 3.2 (prior to that they used Skyhook Wireless). This works by sending WiFi MAC addresses to Apple by GPS-enabled iOS devices. So if the device has a GPS fix, it automatically sends all WiFi MAC addresses it sees alongside with the GPS-detected location to Apple. There’s no option to change this behavior except the master Core Location switch. Users have to accept this transmission of seen WiFi MAC addresses in the EULA.
Location detection via WiFi works the opposite way by sending all seen WiFi MAC addresses to Apple and they respond with the location. Actually they heavily optimize this by caching as many WiFi addresses on the phone as possible. So this even works (to some degree) on iPod touch without any network connectivity.
A weak spot of this algorithm are MiFi and similar devices (relocating WiFi hotspots). Currently, Core Location does not do a very good job of discarding obviously wrong WiFi locations. For instance, on indoor trade shows without GPS reception, be prepared to get wrong location updates because of the many MiFi devices out there.
To respond to your question about manually adding WiFi hotspots: no, there’s no way to do that. Just use a GPS enabled iPhone/iPad running iOS 3.2 or higher and the MAC address will make its way into the database eventually. In my experience, this happens rather quickly.