Set to 'digital' if you are using a digital source, 'analog' if an analog source.
mics, soundboard = analog
spdif coax or toslink optical digital (from analog-to-digital converter, DAT, etc) = digital
The only time I've had mine set to 'digital' was when I tried using it to transfer a DAT to my computer via USB. When recording from mics, and instrument, soundboard you'd want it set to 'analog'.