It toggles whether the keys you press get highlighted or not. I use it when I don't have privacy and don't want someone next to me to see, for example, what password I am typing in.
It's just one of those things in a touch-based world when all you have is a graphic/icon with no text/hint, you are left to try it to see what happens. In the case of an on-screen keyboard, how much damage could you do by pressing such a key?Ah ha! I don't know why I missed that. Works just as you say. Now I'm wondering, did I miss reading about that somewhere or should it have just been obvious?