Physiological O2 gradients are principal regulators of blood flow in the microcirculation: position-to-position changes in hemoglobin (Hb) O2 saturation are coupled to regulated vasodilation (“hypoxic vasodilation”). The mechanism by which graded changes in O2 content of blood evoke this response has been a great challenge to understand. A new role for red blood cells (RBCs) in hypoxic dilation of blood vessels and inhibition of platelet activation involving release of nitric oxide (NO) bioactivity is described. We show that NO groups can be transferred within hemoglobin (Hb) from hemes to highly-conserved cysteine thiols (β-Cys93) to form bioactive S-nitrosohemoglobin (SNO-Hb), and that efficient production of SNO-Hb requires selective processing of NO within the β-subunits. Bioactive SNO-Hb is localized primarily to the RBC membrane through interaction with Band 3, the transmembrane anion-exchanger 1 protein (AE1). Upon deoxygenation, transfer of the NO group from β-Cys93 of Hb to a cysteine thiol within AE1 serves the RBC vasodilator activity. In this way, O2 binding in Hb modulates the release of NO bioactivity. We further show that RBC NO bioactivity is inversely proportional to pO2 and impaired in disease. In an aortic ring bioassay sparged with variable concentrations of O2, addition of normal human RBCs elicited graded responses from relaxation at tissue pO2 (~3–7 mm Hg, hypoxic vasodilation), to loss of relaxation and progressively greater contractions at pO2's of 10–63 mm Hg (hyperoxic vasoconstriction). Notably, RBC SNO-Hb levels and hypoxic vasodilation are impaired in several diseases characterized by vascular dysfunction. For example, in RBCs from patients with pulmonary arterial hypertension (PAH), we found decreased (13% of control) SNO-Hb content (assessed by photolysis-chemiluminescence) and impaired O2-dependent vasodilation (bioassay). RBCs from patients with other ischemic disorders have also been examined: RBCs demonstrate a pathogenesis-based impairment in their ability to mediate hypoxic vasodilation by NO. These results confirm the (patho)physiologic importance of RBC NO, and suggest that RBC dysfunction may contribute to impaired blood flow in diseases of the heart, lung and blood.