There are two potentiometers (horizontal and vertical) plugged into two of the analog inputs of Arduino. The board reads the state of the two potentiometers, and sends them as an ordered pair via USB (technically, it’s via serial, but there’s a built in USB-serial converter on the Arduino) to the computer. A small program written in Processing uses the ordered pairs coming in from the board to draw a line on the screen. As you turn the knobs, you can draw on the screen, just like an Etch-A-Sketch. Over time, the lines fade and disappear.
Nice – this is another great example project to build upon. Visit his site and read more about the setup, download the source code and experiment with your own modifications. – Etch-A-Sketch with Arduino