When a message is sent to an invalid or unreachable address, most of the time you’ll receive back a delivery error message as a response. If correctly formatted, those error notification messages contain a set of data, called DSN (delivery status notification) with information about the kind of error (temporary, permanent, and so on).
The Bounce extension tries to analyze those messages and find out if it has been generated by an email address in your database. If so, it will be marked as “bounced” and never contacted again.