Folkloric, mythical goblins are much more interesting than the “monster ecology” goblinkind that is standard in D&D. I think there is a lot to be gained from trying to access some aspect of the “bogeyman” tradition that originally led to the goblin, rather than the “evil stormtrooper” depiction that has become more common. However, when using goblins, there are a whole set of player assumptions that you have to deal with. If you say “you see 5 goblins”, that will produce a certain quantity of unavoidable meanings in your players’ heads that you probably wish were not there. The first step, I think, is to not mark them as goblins initially, and only later allow the players to identify them. But that still begs the question, what are a more fantastic form of goblinkind that would still work in the context of the game? I don’t think it works to say that they are “really scary” and leave it at that.

Well, who started this modern fantasy trope to begin with? Let’s go back to Tolkien and see what his example actually says, rather than the examples of his imitators. From Wikipedia, on Tolkien’s goblins:

In an essay on Elven languages, written in 1954, Tolkien gives meaning of “orc” as “evil spirit or bogey” and goes on to state that the origin of the Old English word is the Latin name Orcus — god of the underworld.

The article goes on to list 7 possible origins for goblinkind:

1. Made from the earth
2. East Elves (Avari)
3. Sentient beasts
4. Fallen Maiar
5. Corrupted Men
6. A mix of corrupted Elves and Men
7. Some cross-bred with Men

As is often the case, the banal cliches that have come down to us from the followers of Tolkien are not much connected to the actual ideas behind Middle-earth. None of these examples are close to “just some other race that evolved (or was created by a rival god) and came to be opposed to the PC races”. They all focus on the idea of falling from grace, or corruption.

So let’s say that a goblin is a human that has been corrupted by arcane forces, perhaps to be the slave of some wicked magic-user, or demon. Having a savage, id-like, but still clever, servant would be more than a little useful to such a patron. In addition to creation through dark rituals, perhaps there are locations that are sources of arcane pollution which cause nearby residents to slowly become goblins.

Note that this conception does not preclude a dark lord like Sauron from actually raising a horde of goblins, but it does ensure that they are not “just another race”.

And what happens when the corruptor dies before the goblin? Does the goblin slowly revert to his past self? Or does the goblin start to regain his past mind, but remain corrupted in body?

It is also possible that this would still allow for the use of goblins as a PC race to replace halflings, though it would have to be handled carefully to preserve the desired style.