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An Audio Interface converts analog signals, coming from your microphone or musical instrument, into digital signals that a computer or other digital device understands (AD conversion). Conversely, when a digital recording is played back that same interface turns the digital signal into the analog signal you can hear (DA conversion).
To record into the computer you plug things into that little 1/8-inch socket on the side, but how will you funnel all your equipment into that same plug and control each input at the same time?
With an Audio Interface, each channel of analog sound goes in one end and the Interface sends it as digital information to the computer on the other end. Now that you're "interfaced," you can use any of thousands of software packages to record, edit, and listen to your work, limited only by your imagination and the software's abilities.
An Audio Interface can be just a USB connection for an instrument or microphone or it can include other functions, like a preamp to connect a couple of mics, an XLR connection for higher quality microphones, phantom power or a MIDI interface to allow your keyboard (or other MIDI devices) to interact with the computer and other devices.
How an interface connects with the computer varies as well. USB and the new, faster USB-2 connections have become the most popular, followed by even faster Firewire audio interfaces. Most computers can handle USB and many handle USB-2. Firewire is mainly used in Apple Macs and newer PCs. A faster connection reduces "latency,"which is the natural delay caused by the journey of sound through the conversion process.
Many of the interface technologies also incorporate the use of AES/PCIcards, which connect internally to your computer, making it faster than wired connections like USB or Firewire. PCI cards were previously known as "soundcards" which were more common in the years when PC users had to install a separate sound card to listen to or work with music, while Apple included it as part of their basic architecture. Lynx, RME, Universal Audio, and Apogee have devices that use PCI cards to take much of the work load off the computer for a truly "low-latency" connection.
The most sophisticated Audio Interfaces feature the Multichannel AudioDigital Interface, or MADI, which is made for more advanced setups, especially live, where the optical and other types of wiring can be spread over a mile with low latency without any loss in quality. You won't need MADI for your typical home studio, but it is becoming popular for professional applications.