A disk image is a file that contains a complete bit-for-bit record of the contents of a disk, including any applicable filesystem structures, but excluding any error-correction data. Thus it is (at least in theory) possible to mount a disk image and read from and write to it just as with a regular disk. This has a number of applications in several domains of computing.
Disk images can be used for the distribution of software. An archetypal example is the ubiquitous ISO file, which holds a complete disk image of a CD-ROM. These files can (sometimes with great difficulty) be transferred over the Internet and then used to produce an exact copy of the source CD. This is useful both for software 'piracy' and the distribution of Free Software, especially Linux distributions. This form of distribution can often be expedited through the use of BitTorrent. Disk images, with the extension .dmg, are also the standard method of software distribution for Mac OS X. Mac OS X provides simple facilities for mounting these images and copying their contents to the computer's main hard disk.
Disk images are also used in emulation. Most emulated computer systems require some form of emulated disk. A disk image is the simplest and most common way of implementing this. Some emulators, such as the PC emulator DOSBox, eschew this usage for use of the host computer's native drives, but most, especially for older computers, prefer to use disk images stored on the host computer's hard disk. For (primarily) floppy-disk based systems such as the Apple II and Amiga, disk images become analogous to ROM images in console emulation, in that they hold one program (usually a game) and do so separately from any other programs or (most) data.
Another use of disk images is as the host for encrypted and/or concealed filesystems. The most common implementation of this is the Linux cryptoloop driver. OpenBSD probably also contains an implementation of this concept. This use is much less common than the previous two, given that it is newer and addresses a less-common need as most users prefer to use simpler and less intrusive methods of securing their data.
This writeup is copyright 2004 D.G. Roberge and is released under the Creative Commons Attribution-NonCommercial-ShareAlike licence. Details can be found at http://creativecommons.org/licenses/by-nc-sa/2.0/ .