The Use Depth option on the Display Mode dialog, or as can be set in the TerraScan -> Settings -> Point Display, is a modifier to the point display such that points closer to the viewer will be outlined in black so that points on closer to the viewer will stand out on top of the points behind. This has the effect of helping aid with identifying non-ground features in a top down view and enhancing the 3D perception in oblique views. Use depth in the MicroStation CONNECT edition will display vectors and points based on distance, whereas in v8i it will display the vector on top of the point information.
The Depth Separation setting dictates how far from other points a point should be in order to be outlined separately. A setting of 0.5m is a good value for both dense and sparse mobile and airborne data. Making the setting smaller, such as 0.01m, will allow one to review noise in a dataset easier. Making the setting larger will group more points together.