In Kohana (version 3) the function is defined in system/base.php and is a convenience function to aid (as the other answers have mentioned) internationalization. You provide a string (with, optionally, some placeholders to substitute values into the finished text) which is then interpreted and, if required, a translation is returned.
Contrary to assumptions in other answers, this does not use gettext.
A very basic example would be (this particular string is already translated into English, Spanish and French in Kohana):
// 1. In your bootstrap.php somewhere below the Kohana::init line
I18n::lang('fr');
// 2. In a view
echo __("Hello, world!"); // Bonjour, monde!