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This template doesn't do an awful lot on its own. It's basically just an error message. It displays when people accidentally invoke a magic word that has the same name as a template. It explains that magic words are called when a straight line (|) is used after the name, whereas a template requires a colon (:)
In other words, as is explained in greater detail at the MediaWiki site, there is a big difference between these two statements:
{{DEFAULTSORT:Last name, First name}}
{{DEFAULTSORT|Last name, First name}}
This template can thus be used to inform a user that they've used the wrong format for their purpose.