From Wikipedia:
Hip is a slang term meaning fashionably current and in the know. Hip is the opposite of square or prude.
Hip, like cool, does not refer to one specific quality. What is considered hip is continuously changing. The term hip is said to have originated in African American Vernacular English (AAVE) in the early 1900s, derived from the earlier form hep. Despite research and speculation by both amateur and professional etymologists, the origins of the term hip and hep are disputed. Many etymologists believe that the terms hip, hep and hepcat (e.g., jazz musicians' now cliched "hip cat" derive from the west African Wolof language word hepicat, which means "one who has his eyes open".[1] Some etymologists reject this, however, and have even adopted the denigration "to cry Wolof" as a general dismissal or belittlement of etymologies they believe to be based on "superficial similarities" rather than documented attribution.[2]
An alternative theory traces the word's origins to those who used opium recreationally in the 19th century. Opium smokers commonly consumed the drug lying on their sides (i.e. their hips). Because opium smoking was a practice of socially-influential trend-setting individuals, the cachet it enjoyed led to the circulation of the term hip by way of a kind of synecdoche. This theory, however far-fetched, is most certainly disproven by the fact that the term hep was used until around 1940, when it was replaced in popular culture with the term hip for no apparent reason other than to make the word current again.