In the late 1980s terms like LOL were used on BBSes and on Usenet. Perhaps you just aren't old enough to remember that? :-)
Before LOL I'd use hahaha or hehehe all the time as well in IRC, Chat Rooms, BBSes, etc.
* Tiksi slaps bdreadz around a bit with a large trout.
It's the literal sound of a chuckle/giggle/light laughter. So when you say it aloud, you need only laugh naturally.
To see it in action go to http://nicovideo.jp and pick pretty much any video. Start watching with comments on, they scroll over the video, and marvel at the trails of www(wwwwwwwwwww).
Because, like, what do you do when someone puts effort into a joke and you want to give them positive reinforcement, but you're just not in a laughing mood? Or it was funny in the abstract, but you're the wrong audience?
Another approach I've seen was "Heh, that's funny." ... but I'm not sure if that's better or worse than "lol"
The current use of "lol" and "lmao" just makes a whole lot more sense than their hijacked and literal definition... it's about replacing what would normally be subtle visual cues and gestures, which signal acknowledgement and/or encouragement, with something that is universally understood.
And it also symbolizes the disconnect between the online persona on facebook, posting all those cool photos, and the real-world person sitting by the computer all those lonely nights. The emotions and the fulfillment of the emotions have become stilted, computers now provide a superstimulus (https://en.wikipedia.org/wiki/Supernormal_stimulus) that replaces deep, real-life conversations with a steady stream shallow online interactions. Notifications pull us back in for more like an addictive slot machine. And our kids are ill-equipped to fight it, which is why they spend a great deal of their lives addicted to effectively meaningless communication with people who are not next to them:
http://www.buzzfeed.com/benrosen/how-to-snapchat-like-the-te...