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FreeOTFE may sound like a political bumper sticker, but it stands for "Free On The Fly Encryption." The "Free" part is self-explanatory; "On The Fly Encryption" refers to the encrypting/decrypting of data as it is written to or read from your hard disk. The data on your disk (either the whole disk or a portion of it, as you see fit) is stored in an encrypted form, and FreeOTFE handles all read and write requests, so that the operating system, applications, etc, operate normally. Despite what you might expect, speed impact is generally minimal and will probably not be noticed by a user under most circumstances.
The easiest and most common way to use open source program FreeOTFE is to create one or more encrypted files. These files are basically large chunks of disk space filled with encrypted data. Once you have created one, you use FreeOTFE to mount it, and it appears in Windows Explorer as any other hard disk, with a capacity equal to the file size (that is, you create a 30 gig file, and you get a 30 gig virtual hard drive). So long as it's mounted, you use it like any other drive. But when it's dismounted, the contents of the file are effectively incomprehensible without the password, which ought to be extremely hard to guess or to solve by brute force--twenty characters with a mix of cases, numbers, and punctuation is a good minimum.
Another option for FreeOTFE is encrypting an entire partition or physical hard disk. This should be done only on an empty partition, and cannot be done on the boot partition, for obvious reasons. (Other programs, such as the also-free and also-open-source TrueCrypt, can encrypt a volume "in place", encrypting existing data, and encrypt the boot disk as well.) Doing this is most useful if you have a lot of data you want encrypted.
FreeOTFE has a "no install" mode, though it does require Administrator privileges to load the drivers. Using this mode is a good way to put both FreeOTFE and an encrypted volume on a portable drive, either a flash drive or a small USB drive. If the drive is stolen or lost, its contents will be inaccessible, and you can use it on any computer where you have appropriate privileges--for example, this is ideal for transporting sensitive data between office and home environments, or between multiple work computers.
In addition, there is a PDA version of FreeOTFE which creates volumes that work under Windows Mobile 2003 or later, and these volumes, if created in FAT or FAT32 format, can also be mounted on your PC. Finally, there is a version called FreeOTFE Explorer, which is "driverless," so it can be used on any system, but it supports only FAT32 drives, which are limited to 4GB files.
While FreeOTFE will work under 64-bit Windows Vista and Windows 7, it does not have signed drivers, which those systems require. The FAQ details a number of ways to overcome this, but all of them have some drawbacks or complications. Getting signed drivers is a stated development priority.
FreeOTFE is a good choice if you need to mount volumes on Windows PDAs as well as PCs, and the FreeOTFE Explorer option allows you to have an encrypted volume even when you lack Administrator privileges, both of which are reasonable use cases. (These additional programs are not part of the FreeOTFE download, but they work with FreeOTFE volumes, so it makes sense to use FreeOTFE in all the environments you work with.) In addition, FreeOTFE offers more cypher and hash options than TrueCrypt, which can be important if you have a preference or a mandate for a particular algorithm. Being free and open source, there's little reason not to test it against other encryption solutions and see if it offers a better selection of features for your needs than the competition.