It's used for proxying requests to other servers.

An example from is:

http {
  upstream myproject {
    server 127.0.0.1:8000 weight=3;
    server 127.0.0.1:8001;
    server 127.0.0.1:8002;    
    server 127.0.0.1:8003;
  }

  server {
    listen 80;
    server_name 
    location / {
      proxy_pass 
    }
  }
}

This means all requests for / go to the any of the servers listed under upstream XXX, with a preference for port 8000.

upstream defines a cluster that you can proxy requests to. It's commonly used for defining either a web server cluster for load balancing, or an app server cluster for routing / load balancing.

If we have a single server we can directly include it in the proxy_pass directive. For example:

  server {
    ...
    location / {
      proxy_pass 
      ...
    }
  }

But in case if we have many servers we use upstream to maintain the servers. Nginx will load-balance based on the incoming traffic, as shown in this answer.