What is a transponder key?

A transponder is short for: transmitter + responder.
 

The word came into use around 1944. In basic terms a transponder is a miniaturized electronic chip that has what is called nonvolatile memory. Nonvolatile memory is the type of memory that does not need constant energy for retention. Along with that electronic chip is a set of windings, very fine wire coiled around a tube. These windings
look similar to the windings you would find in a electric motor.

There are two basic types of transponders. The first are the Electric Coupled Transponder systems. Electric coupled transponder systems  are not limited to small areas for transmission but can transmit  messages or signals for different ranges of distance including several  inches to miles, as used in Satellites and Airplane's. These systems  require large amounts of constant electricity to operate.
 

The second type is what automobile manufacturer’s are using and  they are called Magnetic Coupled Transponder systems. Magnetic  Coupled Transponder systems are passive in nature. This means they  do not require constant electricity and thus do not need a power  source of their own. They operate in the frequency range area of  125KHz. Since Magnetic Coupled Transponders do not have their  own power source they are very limited to range of communication  and generally operate in the range of 1cm to 15cm. Since this is a  radio frequency it can penetrate materials that would make the transponder not directly visible, such as the plastic or rubber in the bow of a key.
 

The process of key identification is similar in most automotive transponder systems. Once a key is inserted into the ignition lock and turned to one of the ‘on’ or ‘run’ positions, the induction coil that is mounted around the ignition lock sends out an electromagnet field of energy. The windings in the transponder chip absorb that energy and power the electronic chip to emit a signal. The signal is usually an alphanumeric set of digits which is considered the Identification Code. The induction coil reads the signal and sends it to some type of computer device to recognize the signal. If the signal is recognized as being already in the computer’s memory the signal is accepted and other electronic components in the vehicle are set into motion to allow the starting of the vehicle or the continuation of the engine running.