I'm interested in this too. I have unreleased music that I've made and it somehow generates reasonable similarities to other music in my library. It can't be simply pulling the info from the net since the artist name I'm using isn't out there anywhere. Some kind of spectral analysis maybe?

I've seen artists from the same genre in these sections, but that might just be correlation. You could always just check the source code I guess.

This is freaking cool

I could be completely wrong, but I know they have a tagging system in place. The tags presumably come from metadata providers (they give basic information about the song, like who wrote it and when it was made, as well as pictures for album covers and such). After that they can pretty easily look for similarities, eg. two items both tagged funny. If you were concerned that they upload your listening history somewhere to come up with recommendations, they do not.