The <(foo | bar) syntax evaluates to a file path, e.g.

  $ echo <(echo hi)
  /dev/fd/63

If a program reads from that file path, it gets the output of the command chain.

  $ cat <( (echo foo; echo bar) | grep bar )
  bar

Of course, that's a silly example. But that explains how the diff example works, since it's the same idea: diff just reads from the two "files".

EDIT: Heh, 5 different replies within the same 60 second window.