It’s fairly straightforward – advertisers who want their sites associated with specific keywords simply buy ads. Links to those sites are then added to publishers sites whenever those words pop up in content. These aren’t ghost links like Kontera and others include in content – they’re full blown links without any notation (like a nofollow) that they are advertisements meant primarily for SEO juice.
Update: Google’s Matt Cutts emails:
Google has been very clear that selling such links that pass PageRank is a violation of our quality guidelines. Other search engines have said similar things. The Federal Trade Commission (FTC) has also given unambiguous guidance on this subject in the recent PDF at http://www.ftc.gov/os/2008/03/P064101tech.pdf where they said “Consumers who endorse and recommend products on their blogs or other sites for consideration should do so within the boundaries set forth in the FTC Guides Concerning Use of Endorsements and Testimonials in Advertising and the FTC’s guidance on word of mouth marketing,” as well as “To date, in response to this concern, the FTC has advised that search engines need to disclose clearly and conspicuously if the ranking or other presentation of search results is a function of paid placement, and, similarly, that consumers who are paid to engage in word-of-mouth marketing must disclose that fact to recipients of their messages.”
Oh, but you say your blog isn’t in the U.S.? Maybe it’s in the UK? Then you’ll be interested in
http://www.opsi.gov.uk/si/si2008/uksi_20081277_en_5#pt11 which covers unfair trade practices and specifically mentions “Using editorial content in the media to promote a product where a trader has paid for the promotion without making that clear in the content or by images or sounds clearly identifiable by the consumer (advertorial).”
But you’re not in the UK? I believe many of the unfair commercial practices directives apply through Europe, e.g. http://ec.europa.eu/consumers/rights/index_en.htm to prohibit misleading or aggressive marketing.
The reality is that accepting money to link to/promote/market for a product without disclosing that fact is a very high-risk behavior, in my opinion.