Latency refers to a short period of delay (usually measured in milliseconds) required for the conversion between analog and digital representations of the sound data. Devices such as computers can only process digital data. Thus, the analog data it receives on microphone or line-in inputs must be converted to digital data. After processing of data, the processed data must be converted back to an analog signal before it can be output to speakers and played back.
This conversion between analog and digital takes a short amount of time, which is known as latency.
One example of latency is a MIDI controller connected to a computer controlling a VSTi. When the user hits a key, an audio signal, which is analog, is transferred along the connecting wire in the form of electrical current. The computer would then convert the signal to a digital format and process it according to any settings input by the user. After the processing is complete, the processed digital signal is converted to an analog sound wave (represented by current in the wire), which is then sent to the speaker.
See also: Buffer Size.