The team was founded in early 1925 by Magallanes' footballer David Arellano, who led a group of young players leaving the club after institutional problems.[13][14] Finally, on 19 April, Arellano and the other youths officially established the club after meetings and negotiations, where Luis Contreras chose the name of «Colo-Colo» for the club,[15] which refers to the homonymous Mapuche cacique Colo Colo.

The team began to play friendly games, but in 1926, Colo-Colo took part in the Metropolitan League of Honour, where they were proclaimed champions and earned the nickname of «invincible».[16] The following year, Colo-Colo became the first Chilean football team to participate in a tour across Europe. However, on 2 May, during an exhibition match against Real Unión Deportiva at Valladolid, the team founder and captain David Arellano was critically injured after suffering a collision with an opposing player that caused him Peritonitis.[17] The inflammation would lead to his death the next day.[18] Despite the great impact caused by the death of Arellano, the club won the tournament of the Central League of football — then renamed Asociación de Football de Santiago — in the 1928,[19] 1929[20] and 1930[21] seasons.

In the 1931–32 season, Colo-Colo suffered its first institutional crisis because of financial problems, which led to a salary reduction for first team footballers and board members, with their consequent resistance.[22] The team played another tournament final that season against Audax Italiano. However, due to a collapse of a platform at the Estadio Italiano and subsequent roughhousing by fans, the game was suspended while the «Albos» were winning 2–1. That day's tragedy resulted in 130 injuries and three deaths.[23] The match was canceled and the champion position for that year remained vacant.[23] Other authors however declared that both Audax Italiano and Colo-Colo were declared champions