Low levels of oxygen (O2) occur naturally in developing embryos. Cells respond to their hypoxic microenvironment by stimulating several hypoxia-inducible factors (and other molecules that mediate O2 homeostasis), which then coordinate the development of the blood, vasculature, placenta, nervous system and other organs. Furthermore, embryonic stem and progenitor cells frequently occupy hypoxic 'niches' and low O2 regulates their differentiation. Recent work has revealed an important link between factors that are involved in regulating stem and progenitor cell behaviour and hypoxia-inducible factors, which provides a molecular framework for the hypoxic control of differentiation and cell fate. These findings have important implications for the development of therapies for tissue regeneration and disease.