Bluetooth is a networking standard that works at two levels:
It provides agreement at the physical level -- Bluetooth is a radio-frequency standard.
It provides agreement at the protocol level, where products have to agree on when bits are sent, how many will be sent at a time, and how the parties in a conversation can be sure that the message received is the same as the message sent.
The big draws of Bluetooth are that it is wireless, inexpensive and automatic.
Bluetooth is intended to get around the problems that come with infrared systems i.e. 1. line of sight 2. one-to-one connection.
The older Bluetooth 1.0 standard has a maximum transfer speed of 1 megabit per second (Mbps), while Bluetooth 2.0 can manage up to 3 Mbps. Bluetooth 2.0 is backward-compatible with 1.0 devices.
Bluetooth networking transmits data via low-power radio waves. It communicates on a frequency of 2.45 gigahertz (actually between 2.402 GHz and 2.480 GHz, to be exact). This frequency band has been set aside by international agreement for the use of industrial, scientific and medical devices (ISM).
One of the ways Bluetooth devices avoid interfering with other systems is by sending out very weak signals of about 1 milliwatt. By comparison, the most powerful cell phones can transmit a signal of 3 watts. The low power limits the range of a Bluetooth device to about 10 meters (32 feet), cutting the chances of interference between your computer system and your portable telephone or television. Even with the low power, Bluetooth doesn't require line of sight between communicating devices. The walls in your house won't stop a Bluetooth signal, making the standard useful for controlling several devices in different rooms.
When Bluetooth-capable devices come within range of one another, an electronic conversation takes place to determine whether they have data to share or whether one needs to control the other. The user doesn't have to press a button or give a command -- the electronic conversation happens automatically. Once the conversation has occurred, the devices -- whether they're part of a computer system or a stereo -- form a network. Bluetooth systems create a personal-area network (PAN), or piconet, that may fill a room or may encompass no more distance than that between the cell phone on a belt-clip and the headset on your head. Once a piconet is established, the members randomly hop frequencies in unison so they stay in touch with one another and avoid other piconets that may be operating in the same room. Let's check out an example of a Bluetooth-connected system.
Adopted from HowStuffWorks, Inc. Please visit the following to know more - HowStuffWorks - Bluetooth
The official site for Bluetooth technical information is this one.