A cutaneous dermoid cyst results from an alteration in fetal development at the lines of cleavage and is postulated to result from entrapped ectodermal cells during embryonic development. The cyst contains a keratinizing epithelial lining, sebaceous glands, eccrine glands, and sometimes lanugo hair. Dermoid cysts may be cutaneous or deeper. Cutaneous dermoid cysts are typically seen at birth or noticed shortly thereafter. They are typically found on the head. They may have intracranial connections; thus, biopsy and removal should be done by an appropriate surgeon to avoid neurological complications, such as central nervous system (CNS) infection that could lead to frontal lobe abscess, meningoencephalitis, or seizures.

Non-cutaneous dermoid cysts can be found inside the skull, spine, and reproductive organs.