Below the thunders of the upper deep,
Far far beneath in the abysmal sea,
His ancient, dreamless, uninvaded sleep
The Kraken sleepeth: faintest sunlights flee
(excerpt from The Kraken by Alfred Lord Tennyson, 1809-1892)
Like most traditional sailor legends, the legend of the Kraken is less than believable in its original form. The Kraken is a huge sea-creature, miles long, that feasts on the ships and sailors alike.
But first, a bit of linguistics: The name Kraken is the anglification of Kraka or Krage, the old Scandinavian word for a tree trunk with its branches cut partially off, that was used for a ladder. It was probably named so because of its reportedly stocky body and multiple arms and tentacles. In some accounts, it was even dragon-like, having multiple horned heads like those of Scylla.
The most likely explanation for the Kraken story must be a giant squid-sighting by a sailor. Which is not strange, when one thinks about it. Squids have been reported as attacking ships innumerable times, and still reports abound. The most likely cause for their behaviour would be a hungry squid mistaking the ship for a whale.
As the story was told and retold from sailor to sailor, it grew like the creature, eventually being of the size of a smaller island (stories similar to those of Sindbad in 1001 Nights are plentiful). In 1555, Swede Olaus Magnus described a cuttlefish or squid-like creature in his Historia de Gentibus Septentrionalibus (History of the Northern Peoples).
The first source recorded by a somewhat reliable witness are from 1752 when the Bishop of Bergen, Norway, Erik Ludvigsen Pontoppidan wrote The Natural History of Norway. In it, he describes a floating island, over a mile across. "It seems these are the creature's arms, and, it is said, if they were to lay hold of the largest man-of-war, they would pull it down to the bottom."
Another Bishop from Midaros near Trondheim, Norway tells of a finding a cliff on the shore and celebrating mass on it. After the mass, the rock slipped into the water and revealed itself to be a Kraken.
While these accounts are arguably not very accurate when compared to current knowledge of the North Sea, they give a quite good impression of the superstition and danger of sailing. Later recordings have seen the Kraken diminish in size as more scientific methods made their progress.
In more recent times, several types of giant squid have been found, although none measuring up to the Kraken. A cephalopod (the infamous 'mystery squid' of earlier this year) has been discovered in the oceans surrounding South America, but it's a mere 20 feet (or roughly 6.5 meters).
Maybe the Kraken took to hiding in the Loch Ness lake via an underground tunnel, or maybe he went to sleep in his submarine palace in R'lyeh.
Sources: Museum of Unnatural Mystery at www.unmuseum.org and Occultopedia.com