When you make digital videos, the files in their full-quality format are huge. Think 1G per minute of audio and video, then add graphic files, effects, and extra soundtrack. Digital video files are also not created in a form which can be shared, such as .dv files or .fcp files. So, first you need to export the digital video files just to share them; but even when a digital video file is exported as a full-quality Quicktime movie file, it can be huge. The file will most likely be way too large to post on a website, since a huge video file will drastically increase download time, and will take up too much of your allowed space on a vide sharing site like YouTube or Vimeo. If you want people to be able to download your video as a Podcast, or on their own computer or handheld device, the file will need to be even smaller. What is the solution to this problem? Compression, which is also referred to as encoding, makes the file smaller; in other words, “smooshes” it.
When you compress a video file, the negative result is that you lose a lot of the image and sound quality, but there is no other feasible way to share your video projects over the internet. So, video compression is necessary for sharing digital video files in several capacities, including: exhibition on a personal website, uploading to a video sharing website (like YouTube,) podcasting, and even burning a DVD.
For an official explanation of Video Compression, see the Wikipedia entry.
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