Kraken skin, also known as "kraken leather", is dropped exclusively by the Kraken boss of the ocean. It was added in the Vamos a la Playa update. Due to the Kraken's health and attack power, this item is very rare.
Kraken skin is used to craft the diving suit, which is an upgraded version of the diving mask, and the super hammer, which is the highest tier of hammers. However, it is recommended to craft a diving suit first as it may be more useful and the super hammer can be found very rarely in Treasure Chests.