An MP3 is a digital audio file compressed with a standard defined by the Motion Pictures Experts Group (MPEG). MPEG was formed to develop techniques for dealing with digital video; since most video also contains audio, MP3 was developed as an audio extension of that work. Officially known as "MPEG-1, Layer 3", MP3 is a lossy compression algorithm that uses psychoacoustic modeling to reduce the size of audio files by up to 90%.

Psychoacoustics takes advantage of deficiencies in the human hearing system to throw away digital bits corresponding to sounds that cannot be heard. The human ear cannot hear soft sounds in the presence of loud sounds having a similar frequency; for example, a voice conversation becomes inaudible when a jet flies low overhead. This effect is known as auditory masking, and done correctly the discarded sounds will not be missed.

MP3 is a lossy algorithm in the sense that the original bits cannot be recreated from the compressed bits. In terms of hearing, however, MP3 is lossless because the human ear cannot distinguish between a CD recording and a properly encoded MP3 version of it. MP3s achieve this transparency at a bit rate of approximately 256 kilobits per second, or roughly one sixth of the 1.4 megabits per second required by the compact disc format.

MP3s can be recorded at lower bit rates, saving even more space, but audible differences begin to appear at rates below 128 kilobits per second. At these lower bit rates, MP3 can use a trick known as joint stereo to improve quality. Audio generally consists of left and right audio tracks. Joint stereo combines, whenever possible, the sounds common to both left and right tracks into one track. Instead of left and right, it has "common" and "different" channels.

Being an open standard, and therefore available to anyone, has played a major role in the widespread adoption of the MP3 file format. While specific implementations such as those by the Fraunhofer Institute may be protected by patents, there exist numerous open source implementations. MP3s were originally only playable on computers, but inexpensive, portable MP3 players such as Apple's iPod have since been developed.