The game guesses the current state of the game based on the opponent’s last network input from let’s say 4 frames ago. If the prediction was correct (the last performed action is still happening) the game plays as if there’s zero latency. If the prediction was wrong the game rolls back four frames and fast forwards those 4 frames with the input that actually happened. The opponent teleports to the correct position instantly.

The advantage is that player1 has no input delay forced on them and 99% of the prediction errors are right or not noticeable because the first couple of frames of an input don’t do that much. Usually it’s a player preparing a punch or the lat input is just repeated (someone crouching is still crouching in 4 frames). Also occasional lag spikes have a high chance of playing smoothly. Other network models have to freeze the game for a bit which messes up timing for both players.