Literally, dither is noise added intentionally to a digital recording. Low level signals are difficult for digital gear to record; the sampling machine simply has difficulty deciding whether the necessary bits should be turned on or off, creating "quantization noise." By adding a small amount of very controlled noise to the original signal, the bits can be made to positively switch on or off, improving low level sound resolution. The noise used is often "shaped" to be in-offensive to human ears. Good dithering algorithms, whether hardware or software based, can make an incredible difference in the sound quality of a digital recording!
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