VoIP allows users to make phone calls using an Internet connection rather than a traditional phone line. It works by converting the voice signal from analog to digital, breaking it into packets, sending it over IP, reassembling it at the destination, and converting it back to analog. VoIP has advantages like low cost and portability but disadvantages like quality issues during power outages or network instability. Major challenges include addressing latency, echo, jitter, connection problems through firewalls and NAT, and overall reliability.