Wiktionary
n. (context humorous English) The strong caustic smoke produced by overheating electronic circuits or components.
Wikipedia
Magic smoke (also factory smoke, blue smoke, or the genie) is a humorous name for the caustic smoke produced by burning out electronic circuits or components, usually by overheating, overvolting, or connecting them incorrectly. The smoke typically smells of burning plastic and other chemicals, and sometimes contains specks of sticky black ash. The color of the smoke depends on which component is overheating.
The name is a running in-joke that started among electrical engineers and technicians. It was more recently adopted by computer programmers. The given device operates until the smoke is released from it, at which point the device ceases to operate. Ergo, the smoke is an essential part of the device's operation, through undetermined ('magical') means. The joke's humor operates via the logical consistency of what is observed, versus knowledge of what is actually occurring. This is an example of the fallacy post hoc ergo propter hoc.