When working with Office 365, there are 3 ways to provide user identity:
- Manage all users in Azure Active Directory. In this case, there is no traditional active directory; AAD is managed in the cloud
- Synchronized Identity. In this case, user identity is synchronized between Azure Active Directory and traditional Active Directory. This is done by using a tool such as DirSync. For more information click here. Here, a user would sign in to their computer using their Active Directory credentials, and then if they wanted to access cloud services such as Outlook.com, they would need to sign in again.
- Active Directory Federated Services. In this case, a user would log onto their computer using their credentials, and then they can go straight to Outlook.com without having to enter their credentials again. The key here is Single Sign On (SSO).
Which one you choose will depend on what you are trying to achieve and your environment.