In some camera apps (native camera app in 2.2, Camera 360), "zoom" zooms in on the image -- filling the entire screen with a closer-in view of what you're shooting. In at least one app (Vignette [see below]) "zoom" shrinks the picture down. The latter behavior -- along with surely-lacking mechanical lens focus mechanism -- suggests that all of these zooms are purely digital, and not optical.
See Also: Can a Dream's camera really zoom from the camera app? [device-specific question]