The short answer is no one is really sure. What is known is that they are benign soft tissue growths that usually appear at the wrist, but can occur at virtually any joint. Under a microscope, a ganglion cyst consists of loosely oriented sheets of fibrous tissue with a few live cells to maintain and repair the fibrous tissue layers. They are filled with a gelatinous material that resembles synovial fluid, the fluid that lubricates joints, but is thicker and the components are in different proportions than in synovial fluid. Ganglion cysts are connected to joints by tortuous pedicles, or stalks.

Theories abound regarding how the ganglion cyst developed. Originally, they were thought to be simple herniations, or out-pouchings, of the lining of a joint, but as there is no synovial lining present within the cyst on microscopy, this is unlikely. They have also been postulated to be due to chronic inflammation, or irritation of the joint, but likewise there are none of the typical cellular inflammatory changes in a ganglion cyst, making this theory unlikely as well. Three of the most plausible theories are: 
1) The capsular rent theory: A tear forms in the joint capsule, the fibrous coat of a joint sealing it off from outside tissue and keeping synovial fluid in the joint. This may be due to poor functioning of the joint leading to areas of weakness in the capsule. Some of the synovial fluid leaks out, eventually forming a cystic wall of fibrous tissue around itself. 
2) The mucioid degeneration theory: Joint stress leads to degeneration of the connective tissue (soft tissue) near a joint causing fluid accumulation and formation of a fibrous cyst around the fluid. 
3) The mucin secretion theory: Joint stress causes mucin to be produced by the live cells in the soft tissue which coalesce into pools of mucin which then forms a fibrous cystic wall around itself.

None of these theories completely explain all the elements and behaviors of a ganglion cyst.

As stated above, a ganglion cyst (about 80-90% of them) forms around the wrist. 60-70% form on the back of the wrist, 13-20% form on the palmar side of the wrist. They are small, usually only 0.5-1 inch (1-2 cm) across. They feel firm and rubbery, and are not mobile i.e. do not move under the skin when manipulated, indicating that they are tethered (the tether being the stalk that attaches them to a joint). Sometimes they cause pain, sometimes not. They can cause aching that radiates up the arm with activity or manipulation of the cyst. On the palmar side of the wrist, they can cuase numbness or tingling due to compression of nerves. They may also decrease range of motion of the wrist due simply to their size, and may even decrease grip strength.