MD5 is a one-way message digest algorithm defined in RFC 1321. It can be used to encode a value of an arbitrary length into a 128-bit value that cannot be reversed to determine the original cleartext. It is commonly used as a mechanism for checksumming data, and it is also commonly used for encoding passwords and other sensitive information.
Note that recent advances in cryptography have discovered weaknesses in the MD5 algorithm. These discoveries do not directly impact the security of the way that the MD5 algorithm is used by the directory server, but nevertheless it may be wise to use a stronger mechanism like the Secure Hash Algorithm.