interact is (String → String) → IO (), a function that takes a String → String (a function that takes a string and returns a string) and returns an I/O operation (which is a separate type since Haskell doesn't have side-effects). The function you give it will receive all of stdin as a string and its output will be stdout. The magic comes because Haskell uses cons-lists that are lazy in their spine — the list doesn't actually exist until you look at it. This means that, from your perspective (probably not how this is actually implemented), the list you return is iterated character-by-character, and each character that gets printed only waits for the characters it needs, allowing the rest of the stdin list to remain unevaluated.