Kazaa is harmful to your health and well-being. Yes. The RIAA uses a modified version of the software to spy on you. Kazaa reports the actual machine IP address behind whatever firewall, as well as the user information, protocol, port number, and a bunch of other stuff, then the router plugs in it's own IP address in the transport header.
On a related note, Ed Felten at Princeton University has written a p2p client in Python, with just 15 lines of code, each line having 80 characters or less.