That's how Lively started and we first heard about it last year, when it was tested by some students from ASU. At that time I associated the project with Google Earth, but there's no connection with this application for now.
Lively's goal is to help people "express [themselves] with and without words, and to do this in the places [they] already visit on the web." You can create rooms, decorate them, choose avatars and interact with other people from the room using words or actions. Each room has a permalink and can be embedded in a web page.
To use Lively, you need to download a client that only works in Windows XP/Vista and has plug-ins for Firefox and IE, log in to a Google account and get a Lively ID (Google recommends to choose something different from your Google username). Then you can choose a name and an avatar that can be customized later.
Lively's client also includes support for Google Desktop gadgets and developers can create their own objects with custom interactions.
Many people compared Lively with Second Life and IMVU. "In 2005, [Google] made a secret bid to buy IMVU. The company turned Google down. The search giant did manage to hire one of IMVU's five founders, Mel Guymon," writes Venture Beat. Mel Guymon, who is now Google's Head of 3D Operations, says that "Google making a play validates the space like no one else. We're basically saying this is a real space and everyone is doing this. (...) The implementation of it takes the best of the space, rich avatars and a large catalog of virtual goods, which by the way is free, and have it be a part of your existing social network, which is the big wave right now. That's really the silver bullet."
Lively has the potential to attract some of the people that use social networks and want a fun way to express themselves, but having to download a client that uses a lot of resources, slows down your computer and crashes often is a big downside.
Related:
Google's Lively social 3D world is 20 percent done
Google Lively FAQ