You guys can just update to stock iOS 4.2.1 just make sure you just update, but if you wanna restore, you should make a backup then restore to your last backup. All your saves should still be there. But to get all your pirated apps back you have to re-download them. Same goes for cydia stuff...
Demon, Not sure if you can jailbreak iPod touch 2G MC with the most recent redsn0w. If I recall correctly they removed steak4uce (pod2gs tethered exploit for iPod touch 2G MC)