From SRB

Encrypt1 is a simple, fast, and secure stand-alone authentication system for SRB. It is a password-based authentication option in which the password is used in a challenge-response protocol so that no plain-text password is sent on the network. It uses a one-way hash algorithm such that the password is concealed, yet the client can prove that is has access to the password. There is no encryption going on (just the one-way hash), but it is similar to encryption systems as there are no unencrypted passwords sent on the network, so an eavesdropper would still not be able to authenticate as the user.