It is good practice to have this file, with minimal description of your project (usually called README). Ruby, then GitHub and Node.js have adopted README.md as default.
.md or .markdown are file with text in markdown format. Markdown is markup language, a superset of HTML, with focus on content authoring (not design).
Home page is http://daringfireball.net/projects/markdown/
Markdown is default on http://stackoverflow.com and http://github.com ( see Github Flavored Markdown (GFM))