I don't have much to add, but have used an Omni-Bounce. It's what Paul describes, a translucent cap that attaches to the flash and makes it more omnidirectional (diffused). Since it's still a very small light source, I never saw a huge amount of difference with or without it in my shots.

The really soft diffused light you see with portraits is usually from soft boxes that may be as large as 5' in diameter (or larger, but that usually takes some McGuyver-ing) but usually about 24"x30" or so. These are usually put as close to the subject as possible; just outside of view from the camera. This way the light source stays very soft because even with a soft box that big, if it's 10' away it's small in relation to the subject.

Since on-camera flash is a fair distance away from the subject (usually), you're limited with what you can do. But diffusers can take the "edge" off a little bit. On-camera flashes can also be mounted on a light stand with an umbrella - lots of options...