In a few words, Diald creates a new network interface and sets it as the default gateway. This interface is not real (in the original documentation it is called proxy interface). Diald monitors this interface, and, when packets arrive, makes a ppp connection, waits for it to be stablished and changes the default gateway to this new ppp interface (usually ppp0).
Diald monitors the interface to determine which packets have been received the interface and their types to decide if they are going to be considered to set the ppp connection up, maintain the link, drop it or do nothing, and how long the link should be help up after the packet is transmitted.
Finally, if there is no more traffic and the last packet up time is over, Diald will close the link.
You can control days and hours when the link can go up and when it cannot, so you can use the low cost hours/days or low trafic times.
This previous description is valid for Diald versions from 0.16.5 to latest (0.99.3 when this document was finished), but latest versions also include aditional attributes such as user enabled list, advanced accounting, better support for ISDN lines, better performance using an ethertap device as proxy (this is like a network interface that read/writes over a socket instead of a real network adapter) in place of slip, backup connections and other functions.