Look at the two images below:
Both images are identical, but the difference is in hosting. I downloaded the first image and uploaded it to my blog. The second photo is hosted by another website, and I'm displaying it on this post. Although you might not know it, you, as the reader, are downloading both images onto your browser and using bandwidth from the servers hosting these images, and bandwidth ain't free.
In the first instance, image theft is quite obvious if I claim it as my own without giving credit (to myself because it is mine), but in the second instance, it's hotlinking which is bandwidth theft. The image has not been downloaded to my computer or moved. I have not uploaded it to my blog. The URL is easy to find and trace (back to my Instructables account).
If you click on the first image, you will see the URL of the image displayed. If you were to hotlink to that image, all you would have to do is throw the URL in some HTML code and off you go which is exactly what I did in the second instance. It's easy enough to do and isn't really image theft since it was never uploaded to a different server or taken from the site, but it most certainly is bandwidth theft and pretty darn rude.
It's so rude that if you hotlink, you might get one of these images in return:
Or a whole lot worse depending on how much porn the person you're hotlinking to has... Another reason to avoid hotlinking is that URLs change or images get removed, and you're left with a big, ugly broken image.
If you find one of your images on another site, check the URL of the image and see if it matches the URL of the image you're hosting. If the URLs match, then it's hotlinking. If the URLs don't match, then it's potentially image theft. It could also be hotlinking, but that would involve someone else taking the image, hosting it, and then someone else hotlinking to that image...
Anyway! Hotlinking involves a bit of code and doesn't mean an image was downloaded and uploaded to a separate site/host/server. You can still trace a hotlinked image back to its source (although Picasa certainly makes that difficult), but it's best to never, EVER hotlink.
In general, if you have to borrow an image, upload a smaller image to your own site and give credit to the source. A smaller image gives the general idea, discourages image theft, and encourages people to follow the link if they would like to see a larger image. It also saves space on your blog/server/host. Most people publishing images online do not mind their images being used on other sites so long as credit is given and a link is provided. Links improve a site's Google rank, and publicity is generally appreciated.
For the record, I asked a staff member at Instructables if it was ok for me to hotlink for this post and got the green light.
If you want to curb hotlinking, check out this article.