What is liberation or enlightenment?

Enlightenment is full realization of our true nature. It is breaking through the trance thrown up by the individual mind. It is like realizing that the movie is only a play of light on the screen, that the screen (consciousness) is the only true reality, we are only creating a story and mistake that for reality on the basis of some flickering light. This realization is only possible when no longer attach such importance to the phenomena, when dispassionate. Once we see this, the world (mind) becomes our home or playground instead of a prison. It is a fundamental change of point of view. Instead of taking as the center this dead mind with its shadowy objects that are lit up by consciousness, we detach from all that and take consciousness as the center and abide in it. We can still enjoy the world, even to point of experiencing it as blissful, we still participate and because we are happy we spread love. It is not something that can be 'done' it is something that will happen when the mind is undisturbed. The mind can only be undisturbed when it no longer identifies with Ego as a result of insight and practice.

How do we know there is something like liberation?

We know it is possible from the ancient scriptures that have stood the test of time. People that have entered this state, from the goodness of their hearts, have told the unenlightened about this possibility. But even in our daily experience we can intuit it by seeing the ugliness of Ego rearing its head, we see the confusion and all pervading neurosis resulting from identification with Ego. We see the pettiness, so aptly portrayed in the classic 'The Catcher in the Rye'. We see that happiness and love thrive only when the role of Ego is diminished. We have all experienced the 'flow' state when we forget Ego as all our attention is focused. We observe that everything passes and decays, nothing is permanent. We realize on the other hand that consciousness or awareness itself is permanent and never changing, always fresh and alive.

What is being liberated?

Some people especially in the so-called Neo-vedantic circles, claim that we are already liberated, that there is no need to go on any quest as it would be Ego that embarks on this quest, only resulting in reinforcement of Ego.
However, we are not trying to liberate ourselves. We are liberating our minds. It is mind that is confused. It is mind that identifies with one its functions, namely Ego. Only when mind is clear and undisturbed we can realize our true self. Our true self indeed does not need liberation as it is what it always was, we just don't realize that fact.
It is like saying "there is no need to purify the water, even though we can't see the bottom of the pool, we know it is there". This is just intellectual understanding, since we don't see the bottom it is not experiential. Only experiential knowledge can change us.