After downloading the 2.5-megabyte Skype program, Internet-connected users can make phone calls using a microphone headset and speakers (or a headset) to other users on the Skype network; instead of a standard phone headset, they use a microphone headset and speakers plugged into the computer. The interface is familiar to that of instant messaging program; users can see who on their "friends list" is online, and they can place calls by clicking on graphical icons. Through a broadband connection, the service quality is comparable to that of a conventional analog phone call. Gone are the problems that plagued VoIP's earlier incarnations: static, tinny sound, delays, and dropped calls. Through a dial-up connection, however, sound quality suffers. "

After 10 years of talking about how VoIP can disintermediate the traditional carriers, we're actually seeing some tangible evidence that this phenomenon can become a reality," says Tom Valovik, an analyst with the market research firm IDC.

Making phone calls to strangers isn't much of a draw, so users typically act as recruiters, convincing friends and associates to download the software so they can communicate for free.  Rather than route the calls through a centralized server-the method used by other VoIP companies such as Vonage and 8x8-the calls are routed through other users' computers, the same way Kazaa allows users to download files directly from other users' computers. By dispensing with the cost of maintaining a centralized server, Skype can offer its core service for free. The company eventually plans to charge for services such as voice mail and call forwarding, but none of those services are currently available. 

With Skype's creators' controversial past (Kazaa remains the music industry's public enemy number one) and the program's rocket-like popularity, it's tempting to envision the day when programs like Skype eclipse the major telephone companies. But don't rush to sell your telco stocks (assuming you've held on to some); significant challenges remain before Skype becomes more than a nuisance to the AT&Ts of the world. "Skype will never threaten the traditional phone companies that have billions of revenue," says Kagan. "But it is going to be a grass roots success story."

One of the biggest challenges is that Skype can only be used with other Skype members, similar to how several years ago e-mail services allowed users to exchange messages only with other members of the same service. Until Skype's popularity reaches a tipping point, this relegates Skype to secondary phone line status rather than primary. Second, Skype users can't dial emergency services such as 911. Third, with phone company call rates dropping, offering service for free isn't the draw it once was.

Friis says his company is "in discussions" with other VoIP players to introduce interoperability among their programs. He also maintains that the 911 issue is not a big technical problem and eventually will be addressed.

"Skype has the potential to be bigger than Kazaa," Friis insists. "But the great thing is it doesn't come with the legal issues around it."