Below are my vague recollections of the incomplete description provided by the team behind this feature in the Windows 98 era. The implementation specifics were confidential, and I was not familiar with the details, and for the next 13 or so years since I first experimented with this feature, the situation has changed a bit.
A representative sample of the binary data from the CD was read and converted to some CRC-like checksum or hash. The checksum was sent to the web service containing the database corresponding to these checksums in the album information.
If possible, the exact drive was mapped; Apparently, there were enough conflicts in my own collection, and sometimes I was offered a list of possible albums.
Microsoft spent enough money creating this database, and the data included a partnership with at least one third-party company. You can probably build a proof of concept quite easily, but you probably won't be able to create a complete database yourself. But you can use something like FreeDb to create your own service.
An example of this approach is explained in more detail here: http://en.wikipedia.org/wiki/CDDB
It is possible that the new CDs contain some sort of separate identifier, but I am not familiar with current CD standards.
Jasontrue
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