water is a better conductor of heat than air is therefore water is able to transfer heat from a CPU better than air. Basically you have a special heatsink built which fills with water, the heatsink transfer the heat from the core into the water, and the water is then carried away from the core through a radiator, which acts like heatsink fins.
The hot water is pumped through either small fins, or through long pipes within the radiator, which generally should have active cooling blowing over it, cooling the water down so it can repeat the cycle