TheAncientOne already answered this with the wiki link: http://en.wikipedia.org/wiki/Cel
For Naruto, this was actually done in conjunction with Studio Pierrot and the art studio that still creates cels. An original frame was taken from the animation, then hand-painted and created on a cel (transparent sheet). This is original art created for collectors and fans.
To answer the prize question, for runner ups and honorable mentions, there will be a variety of Naruto items and grab bags worth up to $50. We'll throw a plushie in there since it's been requested
Contest ends February 22 at 11:59PST. Keep those entries coming, especially "Show Us Your Ninja Moves"!