Granular activated sludge has gained increasing interest due to its potential in treating wastewater in a compact and efficient way. It is well-established that activated sludge can form granules under certain environmental conditions such as batch-wise operation with feast-famine feeding, high hydrodynamic shear forces, and short settling time which select for dense microbial aggregates. Aerobic granules with stable structure and functionality have been obtained with a range of different wastewaters seeded with different sources of sludge at different operational conditions, but the microbial communities developed differed substantially. In spite of this, granule instability occurs. In this review, the available literature on the mechanisms involved in granulation and how it affects the effluent quality is assessed with special attention given to the microbial interactions involved. To be able to optimize the process further, more knowledge is needed regarding the influence of microbial communities and their metabolism on granule stability and functionality. Studies performed at conditions similar to full-scale such as fluctuation in organic loading rate, hydrodynamic conditions, temperature, incoming particles, and feed water microorganisms need further investigations.