Vanilla extract, simply stated, is extracting the vanilla flavor from fresh vanilla beans (also called 'cavier') and the vanilla pod using vodka. The flavor is more stable in the alcohol and allows the vanilla to stretch further than if you were just use the vanilla beans.
The pods have a remarkable amount of flavor in them and chopping them extra fine allows you to get more flavor out of them. As a side note - vanilla bean speckles in "vanilla bean ice cream" are normally spent (already extracted) vanilla pods that are finely chopped. If you were able to taste these little black speckles, which you think are contributing to the flavor, you might be sadly surprised.
This photo was taken at time 0, 11/19/12. I'll put a few more updates as they happen, you can see that after 5 minutes of being in the vodka, the liquid is starting to turn brown and the chopped pods have settled to the bottom.
To make your own vanilla, check out this website: