Most of this information is gathered from the official Sonic Channel website.
Chao are described as creatures not possessing the ability to decide its own course of evolution. They are fragile, fleeting, and consequently a pure and lovable life-form.
Typically they live by clear water. They adapt to survive in various environments by being able to capture features of other life-forms that they touch. Watching their exceedingly cute behavior is relaxing.
The earliest we know of Chao, is thousands of years before the events of Sonic Adventure. The guardian of the Master Emerald at this time was a beast known as Chaos.
Chaos is actually a mutated Chao, and possessed high intelligence and abilities that far exceed others. Although Dr. Eggman quoted it as "The God of destruction", it has a gentle personality.
It profited from the power of the seven Chaos Emeralds, situated around the altar of the Master Emerald. They guaranteed clear water around the altar and protected its race from foreign tribes.
However, as seen in the story in game, the ancestors of Knuckles were a war-like tribe, and slaughtered many of Chaos' fellow Chao in order to plunder the Chaos Emeralds. This caused the enraged Chaos to go berserk, absorbing the 7 Chaos Emeralds and transforming into Perfect Chaos.
This caused heavy destructive floods and destroyed the civilization.
This tribe was lead by an Echidna named Pachacamac, who had intentions to conquer other countries.
Pachacamac had a daughter, a kind gentle Echidna named Tikal. She did not discriminate against anyone she met. She cared for and looked after the Chao around the altar, and all the while trying to communicate with her friend Chaos, who was feared by the rest of the tribe for its strangeness.
She was always critical of her father and opposed to his evil intentions, and when the tribe attacked the altar sending Chaos berserk, she linked her conciousness with Chaos via prayer, and they were sealed inside the Master Emerald. For the sake of not repeating the tragedy when (if) Chaos was revived. (and he was, by Sonic at the end of Sonic Adventure)
Chao Island
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