Tor is using onion routing, which is a very well known mechanism for hiding one's source. It is used a lot for sharing copyrighted movies, books, plus things like child **** and drug trafficking that are highly illegal. If you use an application other than your browser on your internet connection (online games, email, etc.) then you will probably not be happy with the results.
If you are interested in how things really work under the cover, go here:
http://www.onion-router.net/Publications.html. I used to include one of the original papers in my graduate network protocols class back in the day.