The term "warez" comes from the word "software", and refers to software which is made available illegally, usually with any copy protection removed. The "z" is appended to most any term associated with such pirated software: applications become "appz," games become "gamez," software cracks to remove copy protection become "crackz." FTP sites where warez are kept? You guessed it: FTPz.
Pirated software, and especially pirated games, has been around for a long time. Many people who owned a Commodore 64, Apple ][, or Sinclair Spectrum had plenty of software cadged from friends and acquaintances. As bulletin board systems (BBS's) became popular, software copying became more widespread. Still, such copying was oftentimes limited by geography. You had to know someone directly or have access to a local BBS to download warez, or know of a group which was selling pirated software.
Software companies were not idle during this time. They added copy protection to their products. Some games required players to type in information from the manual or from a packaged codewheel in an effort to make copies of the game less useful. Others had on-disk protection which prevented the game from being run unless the original disk was in the drive. A few even required the use of dongles, pieces of hardware which attached to a PC's parallel port or a Mac's ADB port, to run.
These approaches, however, had limited success. Dongles added to the cost of developing software, and clever programmers could hack around the protection. Similarly, programs to defeat the common forms of on-disk copy protection were as plentiful as the copied software itself. Text files with the information required to play games protected by manual-based copy protection were also passed around. It was not until the advent of the CD-ROM and the concomitant rise in program size that piracy was slowed.
Even that didn't last for long. The people creating warez versions of games took to "ripping" those games, removing movies and music which weren't absolutely necessary to play the game in order to reduce their size. Archiving tools such as LHARC and later RAR allowed users to compress the ripped game files, then split the resulting archive into diskette-sized chunks.
Recently, warez traders have taken to trading ISOs (or ISOz, if you prefer) of games. Named after the ISO-9660 CD-ROM file system, ISOs are digital duplicates of the CDs on which a program came. By downloading an ISO, burning it to a CD-ROM with a CD burner, and getting any programs necessary to defeat a game's copy protection, warez users can have full copies of games and other software.
Two things have come together in recent years to make home software piracy easier than ever before: the growth of the Internet (especially broadband access to the Internet), and the advent of cheap CD burners. Access to the Internet means access to information, and software is at one level nothing more than information. The world-wide nature of the Internet leads to a much wider selection of warez than before. Instead of downloading warez from a local BBS, people can download from repositories of warez half a world away. CD burners make it easy to archive warez for collection or for sale on auction sites such as eBay. Burners combined with fast access to the Internet make ISO trading possible: files which took too long to download over a 56k modem connection happen in a reasonable amount of time over a DSL or cable modem connection.
It has reached the point where warez versions of software are often available before the official version is. Disgruntled employees give away copies of software, or sell them to teams of software crackers. Game companies send out early copies of games to reviewers; some of those end up in the hands of crackers, giving them the opportunity to distribute "0-day warez" before the game reaches store shelves.
Different people are involved with warez for different reasons. At one end of the spectrum are individual users who download warez to avoid having to buy the software. At the other end are people and organizations which produce and sell illegal copies by the truckload. Selling warez can be lucrative, as overhead and software development costs are negligible.