Like many other "0r" words (like bitchz0r, or hax0r, or sux0rz), this has an unknown origin. But it can be traced back to "lolsaur".
If you are a true lamer, use it. If not, AVOID IT AT ANY COST, or people will start to think you're a moron.
Person1: something REALLY funny
Person2: OMG lolz0rrrr!!!!111
Person1: yaaaaaa bitchz0r die cuz i am teh hax0rz
Person2: kekeke! lolz0r!!!11
Person2: lolz0r!!!111 kekeke omg lolz0r!!!
When you 'pwn' someone extremely '1337', you can also say you 'uberpwned' him.
<lamz0r> kekeke j00 got uberpwned!!!111oneoneone