Blood flow in the microcirculation is regulated by physiological oxygen (O2) gradients that are coupled to vasoconstriction or vasodilation, the domain of nitric oxide (NO) bioactivity. The mechanism by which the O2 content of blood elicits NO signaling to regulate blood flow, however, is a major unanswered question in vascular biology. While the hemoglobin in red blood cells (RBCs) would appear to be an ideal sensor, conventional wisdom about its chemistry with NO poses a problem for understanding how it could elicit vasodilation. Experiments from several laboratories have, nevertheless, very recently established that RBCs provide a novel NO vasodilator activity in which hemoglobin acts as an O2 sensor and O2-responsive NO signal transducer, thereby regulating both peripheral and pulmonary vascular tone. This article reviews these studies, together with biochemical studies, that illuminate the complexity and adaptive responsiveness of NO reactions with hemoglobin. Evidence for the pivotal role of S-nitroso (SNO) hemoglobin in mediating this response is discussed. Collectively, the reviewed work sets the stage for a new understanding of RBC-derived relaxing activity in auto-regulation of blood flow and O2 delivery and of RBC dysfunction in disorders characterized by tissue O2 deficits, such as sickle cell disease, sepsis, diabetes, and heart failure.