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Choices are:

Collection - Lets you view pictures and add them to personal albums.

Digital Camera - Lets you transfer pictures between a digital camera or PSP and the HDD. Since I don't have a digital camera or PSP I can't give information on how this works exactly. I know the camera or PSP must connect to the PS2 via a USB cable, and the PSP and most digital cameras have mini-USB ports on them.

Choosing an album in the Collection brings up a screen similar to this one:

This is the photo album for Venus & Braves from the Namco Channel in the Game Channels after Update was run. Pressing Circle will show the selected picture at full size and clear the background.

This is the information on one of the photos. Every photo I've downloaded and been able to view in the Photo Channel has been JPEG format. I don't know if any other formats will work. GIF is pretty likely but I haven't found any to test.