The watermark is an image, in the form of an individual design element or of an overall pattern, created inside paper during the process of producing the paper.
The watermark is created by causing certain areas of the pulp that makes up the paper to be thinner (or thicker) than the surrounding areas of the pulp. The watermark is normally viewed by backlighting the paper. As light passes through the paper, the areas in which the pulp was caused to be thinner will appear to be a bit lighter in shade as compared to the rest of the paper, and the areas in which the pulp was caused to be thicker will appear to be a bit darker in shade than the surrounding paper. This phenomenon is the result of variations in the opaqueness of the paper.
The image is called a watermark merely because it is created in the paper while it still is (if ever so slightly) wet. But the watermark is not actually created using water. In fact, if a drop of water actually makes contact with a forming piece of paper, the resulting mark is generally considered to be an unsightly imperfection. It is what is known as a papermaker's tear.
It is generally believed that the purpose of the watermark was originally to provide an identification of the paper manufacturer; it was essentially a signature mark. The purpose of the watermark today is security; it verifies the authenticity of a document.