Old-School RJ11-Based Phone
The more correct answer is #1.

Vastly simplified explanation follows:

At the Central Office (CO), there is a transformer with a split winding.  Sort of like a winding with a center-tap, except that the two wires that would be connected together to become the center-tap are, in fact, isolated from each other.

One of those middle connections goes to ground, the other goes to -48 Vdc.  The outside connections of the winding go to the customer premises via twisted-pair wire.  Because the DC supply is fed to the mid-point of the transformer windings, there is nominal -48 Vdc between the conductors on the wire pair.

The telephone at the customer premises uses a carbon microphone (or modern equivalent) which changes resistance as speech sound waves hit the diaphram.  This modulates the current in the line.  Another circuit picks up audio between the conductors to feed the earphone in the telephone handset.

Note that I am leaving out many details (off-hook detection, the hybrid network at the telephone that reduces the amount of talk audio in the earphone, many other details.

The bottom line is that the telephone line looks like a balanced audio circuit with a DC voltage offset superimposed upon it.  Thus: audio is present on BOTH wires in the pair as a differential signal.