While the actual definition of what constitutes Spyware is somewhat vague, there are a few distinguishing points that are generally agreed on. The most common definition of Spyware is a program that sends information from your computer to another destination on the Internet without your knowledge and without your explicit consent. The information can potentially include just about anything stored on, or accessible by your computer. In reality, most spyware programs limit themselves to sending specific types of demographic information, such as the URLs you visit on the Internet, IP and email addresses, or even something as mundane as a cookie.
The potential of these kinds of programs is rather frightening though. On a modern Windows XP based computer, any program installed by a system administrator (that is, any of the users created during the install process, as well as the built in administrator account) has access to all files on the system. This allows all sorts of mischief to be committed with your implied permission.