It works on all image-types including animated gifs! Just click on upload or drag'n'drop your files to this window.
To put it simply, this tool converts images to a Data URI - this is a base64 representation of the image. All converted images could be merged into one file which is served in a single HTTP request - thus reducing server-hits and faster availability of your site.
Among other reasons it is primarily to save HTTP requests. External requests are one of the main issues why pages take so long to load, and this makes it faster.
As expected, there are drawbacks to this approach. They are: