The Wikipedia article on Martian Canals is very good.
The existence of canals in the "martian made" sense, instead of the natural sense, was primarily due to wishful thinking on the part of Percival Lowell. The original intention based on observations made in 1877 was probably natural channels. Quoting a snippet from the Wikipedia article:
The Italian word canale (plural
canali) can mean "canals" (including
artificial canals or ducts) or
"channels" or "gullies". The first
person to use the word canale in
connection with Mars was Angelo Secchi
in 1858, although he did not see any
straight lines and applied the term to
large features —for example, he used
the name "Atlantic Canale" for what
later came to be called Syrtis Major
It is often stated that Schiaparelli
intended the meaning "channels" and
that "canals" was a misunderstanding
or mistranslation into English.
Nevertheless, the English term
"canals" was used from the very
earliest accounts in English, and as
far as is known, Schiaparelli made no
effort to correct the supposed
misunderstanding if he was aware of
it. As the word "canal" can also mean
"channel" or "watercourse" – not
necessarily artificial – in English,
the charge of "mistranslation" is
Lowell was practically obsessed with the idea of there being life on Mars and strongly supported the idea of canals. He was also rich and could afford to build his own observatory and promote the idea. It wasn't right, but he believed (or wanted to believe) it was. I can't find the reference, but I've seen side-by-side comparisons of images of Mars taken at the same time that Lowell made his canal maps and the maps that Lowell drew show no relation to the markings on the images.
As for an optical explanation another quote from the Wikipedia article:
William Kenneth Hartmann, a Mars
imaging scientist from the 1960s to
the 2000s, explains the "canals" as
streaks of dust caused by wind on the
leeward side of mountains and craters.
Remember that these "canal" observations were being made with relatively small, ground-based telescopes. The resolution wasn't that great and many observers never saw "canals" at all. And everyone that did, made different maps which could be explained by the shifting dust blown by the Martian wind from year to year.