Web accelerators reduce latency and download times using various web performance techniques including caching and HTTP compression.
Google's speeds up your browsing experience by acting as a
look ahead accelerator. A look ahead accelerator caches web pages and data for later reuse from Google's servers. When you access a page that has been cached, it loads from the local cache on your hard drive, not the Internet. The result is a snappier feel, that improves the more you use it. It uses client software installed on the user's computer, as well as data caching on Google's servers, to speed up page load times by means of data compression, prefetching of content, and sharing cached data between users.
This is what actually happens:
1. Proxy server redirects your web page requests to Google's servers (except secure web pages [HTTPS] and URLs with query parameters "?")
2. Google logs your requests on its servers
3. Caches copies of previously accessed web pages and cookies locally for fast retrieval, checks last update header for freshness
4. Item 3 above seems to imply that Google sends only new portions of an updated web page, i.e., some form of delta compression (in HTTP 1.1 spec) but we did not detect this
5. Prefetches pages in the background based on your surfing habits
6. GZIP compresses web page content before sending to your computer to minimize bandwidth required
After you download Google's Web Accelerator you first install a proxy server on your computer. This proxy server redirects requests for web pages, except for secure web pages (HTTPS), to Google, which logs these requests. Some web pages may embed personal information in these page requests.
Google receives and temporarily caches cookie data that your computer sends with webpage requests in order to improve performance.
In order to speed up delivery of content, Google Web Accelerator may prefetch webpage content that you did not request, and store it in your Google Web Accelerator cache. Google decides what pages to cache based on aggregate usage statistics as well as the users mouse movements.
When you request a cached page, it is loaded from your local cache saving you time. Most people go to the same sites every day, so Google makes sure your local cache is up to date with the latest information by downloading web pages in the background. They keep all of this surfing data stored on their servers, and Google will surely use this behavioral data to improve their AdWords advertising and search results. That is the price you pay for using Google's free service. Google also compresses pages with Gzip to reduce the amount of data zipping back and forth (mainly back) to and from your computer.
Google's client-side cache is effective for DSL and broadband users but dial-up users should avoid it.
Source
By the makers, themselves
As discussed on Yahoo Answers
CNet - Hard facts about Google's Web Accelerator
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Works somewhat like Windows Prefetcher!!!
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So, in layman terms, it calculates/estimates ur surfing habits, buffers up webpages u frequently visit and stores them up on ur hard disk itself, givin an impression of higher speeds @ the cost of space loss, performance loss &, most importantly, privacy loss. It also stores highly-user-accessed sites on it's servers worldwide & enables compressed downloads of the same to ur desktop from the server near u, when u try 2 access a webpage it has collected earlier.
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Ur speeds musta come down because:
1. U've low bandwidth (a la dial-up)
2. Google's prefetcher is downloadin sites u frequently visit (silently) while u r tryin 2 go online.
3. Ur system is gettin overloaded/over-stressed by Google's calculations
4. All of the above.
