Synthesis of bone requires both essential progenitors to form the various structures and the correct microenvironment for their differentiation. To identify these factors, we have used a system that exploits bone morphogenetic protein's ability to induce endochondral bone formation rapidly. One of the earliest events observed was the influx and proliferation of fibroblastic cells that express both vascular smooth muscle cell markers, alpha smooth muscle actin (alpha SMA), smooth muscle myosin heavy chain, and the monocytic marker CD68. The expression of these factors was lost by days 4 to 5, coincident with the up-regulation of Sox9 and the appearance of chondrocytes. Studies with a cyclization recombination (Cre)/lox system, in which a myeloid-specific promoter driving Cre recombinase can irreversibly unblock expression of beta-galactosidase only in cells of myeloid origin, showed specific activity in the newly formed chondrocytes. These results suggest that early chondrocyte progenitors are of myeloid origin. Simultaneous with this recruitment, we determined that a numbers of these cells were in a hypoxic state, indicative of a low-oxygen environment. The cells in the hypoxic regions were undergoing chondrogenesis, whereas cells in adjacent normoxic regions appeared to be assembling into new vessels, suggesting that the oxygen microenvironment is critical for establishment of the cartilage.