Andrea's giving away our trade secrets. :)
Another method would be with the domain mapping plugin although that would require manual intervention of the site admin for each blog set up. I believe we have one person doing it that way.
The issue is it throws in yet another redirect for each and every page call. I know we have a small setup here that does a million hits every month, let along what an average larger host would be doing. Each one of those is yet another processor call, added to the one already occurring with the subdomain.
Word to the wise: Anyone who tries this on regular shared hosting will get their behind booted off of any decent or subpar (ie $2.95 a month) host. You're just asking for trouble.
Gotta admit that I would either build blog 1 into what your site is currently since it's there in root already or just get another domain and run it along side the first one.
edit: Man, I miss Firefox's spell checker. Poo on IE. :(