Volcano was founded by the soldiers of Colonel Stevenson who mined Soldier's Gulch. The area was rich in gold and soon brought a large number of miners. In 1855, hydraulic mining brought thousands more into the town, and soon Volcano had 17 hotels, theatres, and libraries. The town, located in a deep cup valley in the mountains, was name by miners who thought it was located in a volcanic crater.

To the north of Volcano is the old Emigrant Road and the population areas of Jackson and Sutter Creek to the south. When the Volcano Cutoff (or Pennsylvania Cutoff) was created in 1852, it passed through Volcano. The town benefited from the trade that this road brought into town.

Today, Volcano is part tourist town and part retirement community. Many of the original stone facades of the buildings have been preserved and there are numerous plaques in town describing the various buildings.

The "Old Abe", a six-pound bronze cannon, was smuggled in by the "Volcano Blues" to intimidate the local rebel sympathizers during the Civil War. It was never fired.