Often used in hyperbole. The term stems from videogaming and refers to part of the precarious balancing act which the developers of online games must follow to improve overall enjoyment of the game among users.

In the case of an item, weapon, ability (etc..) which is too powerful (and thus detrimental to game balance), the developers make it less effective by changing it's in game statistics - frequently lowering the potency of the strongest characteristics, or by changing how it behaves completely.

Such changes, when overdone by the developers, are said to "nerf" the item - to make it a harmless, "nerf" equivalent of it's former self (Nerf itself being a popular brand of foam activity toys).

"This spell is getting hit with the nerf bat in the next patch" -- is an example of it in use.