[I was determined NOT to post that overused picture of Heather crying, with half her face out of frame. That pic is like HALF the results on Google images for "blair witch project." So, this is Josh.]
Three unknown actors - Heather Donahue, Josh Leonard, and Mike Williams - were paid (I think) $1000 each to work on this film for almost 2 weeks. They were each given a 35 page backstory of the invented mythology behind the "Blair Witch" legend, which they all thought was authentic until after they finished filming. They were given camera equipment and sent to the woods of Burkitsville, MD to pretend that they were film students researching the story of the witch. Every morning, they would awake to find their daily rations and a film canister that contained envelopes for each of them. The envelopes contained their respective "directions" (e.g., "Mike, you're starting to not trust Heather," etc.). At night, the real directors of the film would skulk around the edges of the campsite and "be" the Blair Witch - i.e., break sticks and make other mysterious creepy woodsy noises. After the actors had shot eight days worth of film, the directors then took that footage and cut it into an actual story.
However, not many people knew any of that before the movie was released. Producers of the film told people that this was actual footage. The three actors were listed on IMDB as "missing, presumed dead" on the movie's page and on their own pages. There were "documentaries" all over television promoting the idea that this was a true story. And it worked like a charm; people came out in droves.
This movie is the ultimate "less is more" film. It gets at the very basic fear of being lost and alone in the woods, where something's out there that wants to harm you. All it takes is an unexpected noise - the slightest hint that you are not alone - to scare you out of your bloomers. And when Heather's fellow filmmakers disappear, you can feel her fear. Especially when you can hear one of them in the distance screaming in apparent torture. And you don't even need to see what's happening, because there's nothing they could have shot that would be worse than what you're imagining.
I don't think this kind of film could be made again - at least, not for the same kind of response. People are much more skeptical of "true" stories, largely because of this movie. What made this movie brilliant was not just the film itself but the fact that audiences were scared before they even saw it. By making it sound like a real story, the filmmakers were able to exploit our fascination with real-life horror and the fact that it scares us in a way that can never be achieved by all the boogeymen and fake blood that Hollywood can throw at us.