Dropbox is a cloud storage application, so understanding the basics of cloud computing will give you an understanding of how Dropbox works. Cloud storage is a term that unfortunately has been butchered as of late, but at its core the term stands for a very specific way of storing data.

Cloud storage is storage that is not locally hosted. The data is stored in physical media like any other data, but the storage media is a hard drive located in some far-off server farm instead of a hard drive in your computer. You'll never see the physical device that stores you data or interact with it directly.

The information that you store is also located on all of your computers that have Dropbox installed, however. This creates a "cloud" of computers, each of which stores the same data and can send that data to any other computer that is part of the cloud. As a result it is no longer strictly accurate to simply say your data is stored on your PC. Instead, the data is stored in the cloud and can be retrieved from the cloud on any computer or mobile device that can access the Internet.

With this said, it should be noted that Dropbox is still not a cloud service if the strictest definition is used, because the synchronization of files on the service ultimately relies on the central server. If the Dropbox servers went down the entire service would be rendered useless until the servers came back online. The data would still be in the cloud - all of your computers have your files - but there would be no way to transfer the files between computers or place new files in the cloud until the server was restored.