There are two official currencies used in Cuba: Cuban convertible pesos (CUC) and Cuban pesos (CUP). These are often referred to as the 'national peso' or the moneda nacional (MN). Tourists use the convertible peso and this is most often used to pay for taxis, hotels, museums, and restaurants.
The CUC was introduced by the Cuban government as a means to remove all foreign currencies from circulation - in particular the US dollar. It's divided into 100 centavos. You can obtain notes in denominations of 1, 3, 5, 10, 20, 50 and 100 pesos and coins are made up of 1, 5 and 20 centavos as well as 1 and 3 pesos. I'd recommend you carry some local pesos (CUP) to buy little things such as snacks, fruits and drinks from street vendors as well as the cheap tickets for cinemas, theatres and local buses.
The CUP is divided into the same denominations as the CUC and the rate of exchange is approximately 1:24.
The best currencies to exchange while you're in Cuba are British Pounds, Euros, Swiss Francs and Canadian Dollars. You'll be charged an 8% fee from the Cuban government to exchange these to convertible pesos, but this is better than paying the extra 10% penalty to exchange US dollars.
For the best exchange rates go to the banks or the CADECA (exchange bureau) kiosks. Never exchange money on the street as you can't guarantee it's real. Working ATMs are quite rare in Cuba, you might be able to find the odd one in Havana and Santiago. Most accept Mastercard/Cirrus or Visa for cash withdrawals, but US-issued cards are not accepted. A credit card cash withdrawal will cost you at least 11% in commission.
The best option is to take enough travellers cheques or local currency to get by. Use your common sense though and don't take them in US dollars. You should also be prepared for potential hassles. Cashing them in is often time consuming and they most likely won't be accepted at smaller hotels or in provincial areas. Best stick to exchanging the money at home before you go then!