Custom audiences are groups of users based on lists that were uploaded, events like a webpage visit or conversion and engagement on Facebook. If you upload a list of 10,000 users, you'll be able to show ads to any of those individuals that Facebook can match with their users.

Once you select the custom audience, you can target inside of that group of people by selecting more characteristics. For example, if you targeted people inside of your custom audience that liked "dogs", the list size might go from 100,000 people to 40,000. You would be targeting all the people inside of your custom audience that like dogs.

Hope that helps!