Huffman coding is a method of compressing data by assigning variable-length codes to characters based on their frequency of occurrence. It creates a binary tree structure where the characters with the lowest frequencies are assigned the longest binary codes. This allows for more frequent characters to have shorter codes, resulting in an optimal prefix code that minimizes the average code length and maximizes compression. The algorithm works by iteratively combining the two subtrees with the lowest frequencies until only one tree remains, with the final tree structure determining the codes assigned to each character.