If everything on the Ethereum blockchain is public, then why is it apparently so useful for managing identity?
From what I gather this has something to do with IPFS, but how does it all work? How do smart contracts enable effective identity management?
For identity management I don't see the necessity for IPFS. The identity portion is all done through private/public key encryption. Since only the holder of the private key can decrypt a message signed by their public key the private key holder can validate their identity. This works in reverse a message signed by the private key holder can be decrypted using the public key validating the origin of a message. Smart contracts do not directly aid this but they can be used to create a DNS type directory of validated identities. I hope that helps, if you need more clarification feel free to ask.
