You want to understand the distinction between the Basic and Digest authentication methods.
Use AuthType Basic and the htpasswd tool to control access using Basic authentication. Use AuthType Digest and the htdigest tool for the Digest method.
Basic web authentication is exactly that: primitive and insecure. It works by encoding the user credentials with a reversible algorithm (essentially base-64 encoding) and transmitting the result in plaintext as part of the request header. Anyone (or anything) that intercepts the transmission can easily crack the encoding of the credentials and use them later. As a consequence, Basic authentication should only be used in environments where the protected documents aren't truly sensitive or when there is no alternative.
In contrast, Digest authentication uses a more secure method that is much less susceptible to credential theft, spoofing, and replay attacks. The exact details don't matter; the essential ingredient is that no username or password traverses the network in plaintext.
Preparing a realm to use Basic authentication consists of simply storing the username/password pair and telling the server where to find them. The password may or may not be encrypted. The same credentials may be applied to any realm on the server, or even copied to a completely different server and used there. They may be stored in a variety of databases; multiple modules exist for storing Basic credentials in flat text files, GDBM files, MySQL databases, LDAP directories, and so on.
Setting up Digest authentication is a little more involved. For one thing, the credentials are not transportable to other realms; when you generate them, you specify the realm to which they apply. For another, the only storage mechanism currently supported directly by the Apache package is flat text files; if you want to keep your Digest credentials in an LDAP directory or Oracle database, you're going to have to look for third-party modules to do it or else write one yourself.
In addition to the more complex setup process, Digest authentication currently suffers from a lack of market penetration. That is, even though Apache supports it, not all browsers and other web clients do; so you may end up having to use Basic authentication simply, because there's nothing else available to your users.