Recent advances in developmental and molecular biology during embryogenesis and organogenesis have provided new insights into the mechanism of bone formation. Members of the hedgehog gene family were initially characterized as patterning factors in embryonic development, but recently they have been shown to regulate skeletal formation in vertebrates. The amino terminal fragment of Sonic hedgehog (Shh-N), which is an active domain of Shh, has the ability to induce ectopic cartilage and bone formation in vivo. Shh-N stimulates chondrogenic differentiation in cultures of chondrogenic cell line cells in vitro and inhibits chondrogenesis in primary limb bud cells. These findings suggest that the regulation of chondrogenesis by hedgehog proteins depends on the cell populations being studied. Indian hedgehog (Ihh) is prominently expressed in developing cartilage. Ectopic expression of Ihh decreases type X collagen expression and induces the up-regulation of parathyroid hormone-related peptide (PTHrp) gene expression in perichondrium cells. A negative feedback loop consisting of Ihh and PTHrp, induced by Ihh, appears to regulate the rate of chondrocyte maturation. The direct actions of Shh and Ihh on stimulation of osteoblast differentiation are evidenced by the findings that these factors stimulate alkaline phosphatase activity in cultures of pluripotent mesenchymal cell line cells and osteoblastic cells and that these cells express putative receptors of hedgehog proteins. In conclusion, hedgehog proteins seem to be significantly involved in skeletal formation through multiple actions on chondrogenic mesenchymal cells, chondrocytes, and osteogenic cells.