Etymology of the word "nerf"?

Nerf has it's own wiktionary entry (with the meaning "to water down, dumb down or especially weaken, particularly in the context of weapons in video games").

Etymology From the Nerf brand of toys designed as non-dangerous counterparts of existing things, such as sports balls and guns.

Once powerful skills, tactics or strategies that have been rendered significantly less effective by changes in game mechanics are said to be "nerfed", as these once potent weapons have since been rendered as powerful as the foam toys.

The word nerf is simply applying the proper noun of the company and product "NERF", which makes and sells air and spring powered guns using foam ammo.

So by saying a stat or character was "Nerfed" you're saying it has been given the same soft, less deadly "foam" coating as NERF applied to guns and ammo.

I'm not sure when it was first used, but it's origins have always been the NERF product.

Nerf was introduced as a trademark name for toys made of foam-like material for indoor play in 1970 (Nerf ball).

The following Wikipedia entry gives info about the term regarding computer gaming:

In video gaming a nerf is a change to a game that reduces the desirability or effectiveness of a particular game element. The term is also used as a verb for the act of making such a change.The opposite of nerf is buff (in one of that term's two usages).

The term originated with Ultima Online, and refers to the Nerf brand of toys which are soft and less likely to cause serious injury. It is used in the context of virtual worlds such as MMORPGs (like UO) and MUDs, but has become a part of the general vocabulary of gamer slang and can be found in various places where adjustment of power levels from one version of a game to the next is relevant.