Obsidian

Obsidian is made when water and lava collide. It is used in the production of Obsidian Skull, Obsidian Brick, and Hellstone Bars. It can be destroyed by both Bombs and Dynamite explosions. The easiest way to collect obsidian is to lead a lot of water into a lava pool and mine underwater. Another way is to use the Earthwelling technique. Note that dumping water directly onto lava from a bucket only creates obsidian if the pool is above The Underworld; otherwise the water will evaporate rapidly.

A Nightmare Pickaxe, Molten Pickaxe, or any of the drills is required to mine Obsidian. Obsidian is not destroyed by Lava, despite not being of blue quality.

Obsidian generator
Obsidian can be harvested by creating a generator. A generator is an exploit that allows the infinite creation of lava and water, to create obsidian. Liquids in Terraria can be duplicated in this way because of a game mechanic in which a full bucket will always produce one full block of liquid, while less than a block of liquid is required to fill the bucket.

This video contains a detailed explanation on how to set up the machine. (instead of just using two blocks on the lava duplicator use three or four, this will allow you to click faster like the water duplicator. since the lava will spread out faster instead of taking a bit longer to actually fall off the block)

With the introduction of mechanisms such as Pumps, wire and timers in 1.1, it is now possible to construct an automatic obsidian generator, which does not require using buckets to repeatedly refill the lava or water vats.

A sample set-up of an automatic obsidian generator can be found here:

Video detailing the construction of a fully automated Obsidian Generator using vats and pumps.

History
Obsidienne Обсидиан