Weird. I've got one of these too.
The iPod plays fine, and when the backlight is off, the display looks fine. Hen the backlight is on, I get some dark lines and a dark splodge in the middle of the screen. The dark regions are mostly black but there are the odd red ones too. The menu and everything works. I don't watch videos because that eats the battery too fast, and the thing is out of guarantee.
The LCD works fine with the backlight off. The backlight power supply might generate a spike when it came on that somehow affected a display (the power supply for an electroluminescent panel generates quite a kick) but these pixels are in exactly the same place. Pushing on the screen makes no difference. Twisting the case hard can make a few pixels change state, but they go back when you stop.
The iPod sits in my rucksack. I don't think it has got wet, but I guess this is possible. However, it should have dried out by now. Perhaps some moisture has got in and is shorting from the backlight to the LCD elements. I have had this for about a week now and it doesn't seem to change shape or anything.