How to do a clean install of Iphone?

if you want to unlock just downgrade the firmware :)
http://www.dkszone.net/downgrade-ios-4-2-1-4-1-iphone-43gs3g-ipod-touch-ipad
http://www.google.com/search?q=How+to+downgrade+iphone+from+4.2.1

Once you have upgraded, your baseband cannot be changed or downgraded (depending on you phone, 3GS or above I believe).  So, at this point, you will need to wait for a future unlock as you will currently not be able to.  Developer and hacker @musclenerd who is one of the unlockers will always tweet with this fact stating "Unlockers, do not update the firmware to preserve your baseband!".  If you are in need of an unlock, you will have to stay on the lesser firmwares in the future or until a new baseband unlock is released.  At this point, to answer your question fully, you cannot change your baseband and you will have to wait for a compatible unlock.  Whether you want to continue upgrading and forget about unlocking or stay on 4.2.1 and unlock in a few months, it is your choice.

thank you SpeedyApocalypse! I am just surprised even with a clean install i cannot downgrade baseband. Do you know if I have a ipsw firmware, how can I perform clean install + jailbreak?

Well, if you managed to downgrade to iOS 4.1, you can jailbreak using L1meRa1n or GreenPois0n.  For a guide, see here: http://www.ipodtouchfans.com/forums/showthread.php?t=318355

As for iOS 4.2, there is a tethered jailbreak released through RedSn0w (tethered means you will have to run a tool upon every restart and reboot).  However, I would not recommend jailbreaking iOS 4.2 as there is not much compatible.  

To do a fresh install, you can downgrade through PwnageTool (like you had said).  If you have SHSHs backed up, you can redirect your hosts file to whatever server the SHSH files are stored, and hold Shift and click on Restore in iTunes.  Then, browse to your selected firmware and simply restore.

Just want to be clear. so you are saying I can use PwnageTool to do downgrade (fresh install) and jail break correct?

And I don't know what is SHSHs backed up, what I have done so far is just to hold Shift, browse the firmware and Restore in iTunes..... is that ok?

thanks SpeedyApocalypse.... but I still don't understand what you are trying to explain.... I am a novice so please forgive me.

Can you just tell me that if I downloaded a firmware and use pwnagetool then use the custom firmware, will I be able to either do clean upgrade or downgrade of my phone? This is the tutorial i followed... http://www.iphonedownloadblog.com/2010/10/20/tutorial-jailbreak-iphone-4-1-with-pwnagetool/

so in this case, I don't need to use any of the tools and SHSHs backup you mentioned above right?

I am not familiar with pwnage tool directly but IF you can get to 4.1 with it, then jailbreak using either that, GreenPois0n, or LimeRa1n.  However, your basement will stay upgraded.  Additionally, if you can indeed diwngrade with pwnage tool, then you wouldn't need your SHSHs saved.