Surround sound first showed up with Walt Disney's "Fantasia" in 1941. To show the movie with surround sound, a movie theater had to spend $85,000 for a special setup that included custom loudspeakers and required two projectors, one running the film and one track of audio plus a second one dedicated to four special audio tracks.
Because of the expense, the full surround-sound system was only installed in two theaters: one in Los Angeles and the other in New York. Many theaters offered surround sound as magnetic-based sound became popular, allowing four or even six channels of sound. Dolby A noise reduction allowed films to have stereo optical tracks, but even Dolby A couldn't compensate for the level of noise if more than two optical tracks were put on the film. A major breakthrough in surround sound came when Dolby Stereo was created.
Using an amazing process called matrixing, Dolby devised a way to use the two optical lines on the film to create four distinct channels of sound:
Matrixing works like Boolean logic by comparing the information on the left and right optical tracks to determine which speaker to send the signal to. For example, if a signal on the left track AND the right track is encoded completely out of phase, it is considered surround sound. When the pickup in the projector reads the optical tracks, it decodes this signal as surround sound and sends it to the rear and side speakers in the theater. If the in-phase signals from the left track AND the right track are identical, it sends the signal to the center channel. Otherwise, it sends the left track signal to the left front speaker and the right track signal to the right front speaker.
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It is interesting to note that Dolby Surround and Dolby ProLogic are the home versions of Dolby Stereo. The same principle applies in these home systems. Four tracks of audio information are condensed into the space of two tracks. If the system does not have a surround-sound decoder, the tracks are treated as normal stereo (right and left) tracks. The key difference in Surround and ProLogic is the center channel. A Dolby Surround system uses the right and left speakers to create a phantom center speaker. This works fine if you are sitting exactly halfway between the two speakers. ProLogic sends the center channel sound to an actual center speaker.
With the advent of digital sound, the capability to offer discrete channels of sound has grown tremendously. "Discrete" means that each channel of sound is encoded separately from every other channel, instead of the averaging process used in matrixing.
For more on surround sound, check out How Surround Sound Works.