Plenty of other very good articles have already been written on the subject. This is what most overclockers aspire to. A peltier and a watercooler an overclocker's dream. Instead, I'll cover the basics of a typical system. Water is capable of carrying a lot more heat away from the surface of your silicon for a couple of reasons.
Water has a higher coefficient of transfer, and a higher specific heat.
Meaning it can pick up heat faster from a hot object, and it can hold more heat energy per specific volume. There are obvious disadvantages, too. Watercooling a PC is a complex, and possibly very risky maneuver. The two heat-moving components are the waterblock, and the radiator. We'll start where the heat does.