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Gzip is a famous lossless file compression tool that reduces the size of data by identifying and replacing repeated sequences with metadata or shorter sequences. This process helps in making files smaller without losing any information, unlike lossy compression algorithms like JPEG. Developed in 1992 by Jean-Loup Gailly and Mark Adler, Gzip addresses the issue of wasted space on computer chips by using algorithms like lz77 to optimize file storage.