The term Daemon was originally coined by programmers of MIT for their Project MAC. The name derived from an imaginary being within Maxwell's demon where the demon constantly worked in the background of an experiment, sorting molecules. This terminology became inherited as a Unix term which serves as a process that runs in the background to take care of certain system functions. An alternative expression believed to have begun the name is a derivitive of "disk and execution monitor.
Technically speaking, a daemon is a small program that handles processes that the parent program or OS cant be bothered to perform. In a Unix enironment, a daemon handles its selected processes by disassociating itself from the tty, becoming a Session and process group leader, staying in the background and constantly forking and exiting which allows the parent process to continue its normal execution. It can also set a root directory as the root directory so the process will not keep any directory in use and therefore unusable by the parent. In a Windows environment, daemon is usually referred to as a service. Many services run in the background of a Windows OS to ensure that everything runs as smoothly as possible while the main OS handles larger tasks. These tasks usually require little or no user input and are launched during the OS boot up sequence.
Often in the file-sharing world, daemons are used to simulate a drive where there may not be one. Daemons can be used to create a virtual disk drive to "play" ISO images of certain disk types. Daemons can range in complexity from CD emulation to even DVD emulation. This opens the possibility for users who do not have a DVD drive in their computer to still run DVD based software from the given ISO. A daemon can also serve as a handy tool for those who just wish to mount a selected ISO and not waste a disk by burning the software to it.