The video compression technology will allow YouTube viewers to download large video files more effectively and will work as part of Google's efforts to up its video-on-demand presence.
Google has already made it clear it is looking to expand YouTube's offering by hosting long-form content on the site as soon as possible, as demand and competition in the VoD market heats up, following the launch of Microsoft's online Player and US-based Hulu's expected imminent launch in the UK.
In March, YouTube allowed content providers the opportunity to sell advertising around their own content for the first time.
Under the terms of the agreement for On2, each outstanding share of On2 common stock will be converted into $0.60 worth of Google class A common stock in a stock-for-stock transaction.
Sundar Pichai, vice-president of product management for Google, said video was an essential part of the web, with high quality video compression technology an important part of the web platform.
Google acquired YouTube in 2006 for £1.6bn.
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