I know that hardware routers (linksys for example) run a mini-linux/unix (or at least from what i've heard they do). Anyway to my question, do hardware routers work by using iptables on the unix system in these routers?

Most probably I would say yes. However, as you might know, the guy that proved this out really needed to hack his own router as linksys denied it was running linux at all. Plus, linksys has added their own code to the linux base, without releasing any under the GPL. Even now as far as I know, it's not over yet and linksys still keep most of the code they added under proprietary licence. So that mean that 1- they could, and in fact probably, use some kind of modified iptables, plus some nice web apps to control it 2- linksys are another bunch of bottom feeder thieving on the OSS community. I won't buy anything from linksys anymore.