How is \unexpanded defined?

\unexpanded is an ε-TeX primitive. If you do

\documentclass{article}
\begin{document}
\show\unexpanded
\end{document}

you'll get in the log:

> \unexpanded=\unexpanded.
l.3 \show\unexpanded

which seems to be redundant information but actually tells you that it is a primitive control sequence. Primitives are listed in the TeX Book or TeX by Topic but you won't find \unexpanded there because it is an ε-TeX primitive. It is described in the e-TeX manual, though:

\unexpanded<general text>.

The expansion is the token list <balanced text>.

[...]

When building an expanded token list, the tokens resulting from the expansion of \unexpanded are not expanded further (this is the same behaviour as is exhibited by the tokens resulting from the expansion of \the<token> variable in both TeX and ε-TeX).

As cgnieder's excellent answer says, \unexpanded is a primitive of e-TeX, that is, an extension of the original TeX language. Primitives don't have a definition, they're commands directly understood by the engine. Some of them are expandable, that is, they don't reach TeX's “stomach” because they are expanded just like macros (the same happens to the conditionals, for example); \unexpanded is one of these macros.

It's a generalization of \noexpand which, in the context of an \edef or a \write, has a null expansion but also the effect of making the next token unexpandable for the task at hand. Thus

\def\foo{something}
\def\baz{else}
\edef\x{\foo\noexpand\baz}

would be equivalent to

\def\x{something\baz}

With \unexpanded you can protect from expansion in an \edef (or \xdef) or \write an entire token list, without the need to prepend \noexpand to all expandable tokens.

Since \unexpanded follows the pattern

\unexpanded <general text>

it has an interesting feature. When TeX wants to expand it, it looks forward to find a <general text> which is defined as

<filler> { <balanced text> <right brace>

and expands tokens to recognize a <filler> and, eventually, the {. A <filler> is just an arbitrary sequence of \relax and space tokens which are simply ignored. The { is an explicit or implicit token of category code 1.

A consequence of this is that

\unexpanded\expandafter{\cs}

will cause the expansion of \cs before the { that starts the list of tokens which will not be expanded any more. Indeed, the definition of \expandonce is

\newcommand{\expandonce}[1]{\unexpanded\expandafter{#1}}

Also \detokenize (another expandable primitive of e-TeX) has the same properties.

Beware of the <filler>: it can cause some unexpected effects under certain circumstances as shown in Get the lion to run in loops. Tersely