You can find Microsoft's explanation of the Windows encryption system
here. That article is aimed mainly at XP Professional users, but the same encryption system works on all of the versions of NT and its descendents, as far as I know.
Some points, translated into real English:
The Windows Encryption system, EFS, is intended to be used with NTFS permissions. The permissions are intended to prevent unauthorized access through normal Windows procedures, and EFS is intended mainly to prevent access by people who have gained physical access to the system, and are attempting to use low-level procedures to bypass the permissions. Neither is a substitute for the other.
Unlike third-party password-based encryptions systems, EPS is intended to be transparent to the legitimate user. Once a user has logged on to Windows, he needs no additional password or log-on to access the encrypted files or folders, if he has appropriate permissions. There are free and paid third-party encryption systems for password-protecting files and folders. I use AxCrypt, a free one, and am perfectly satisfied with it.
EFS cannot be used with NTFS file compression. If a person attempts to encrypt a compressed file, it will be automatically decompressed. If I remember correctly, if he tries to compress an encrypted file, he will get some kind of error message.
Encrypted files will become unencrypted if moved to a non-NTFS volume, but not if they are moved to an unencrypted folder on NTFS.
Certain files, such as system files, cannot be encrypted.
Encryption does not protect against directory listing or deletion by unauthorized personnel. It only protects the internal contents of the file or folder from being read.
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