Due to the size of the Vatican City State, embassies accredited to the Holy See are based in Italy. Embassy officials of other countries also stay in Italy. Treaties signed between Italy and the Vatican City State permit such embassages. The Embassy of Italy to the Holy See is unique amongst foreign embassages in that it is the only embassy based on its home territory.
The Holy See maintains formal diplomatic relations with 176 sovereign states, the European Union, and the Order of Malta; 69 of the diplomatic missions accredited to the Holy See are situated in Rome, though those countries then have two embassies in the same city, since, by agreement between the Holy See and Italy, the same person cannot be accredited simultaneously to both.
This is shown clearly by the fact that Italy recognizes the People's Republic of China (PRC) and the PRC's Embassy to Italy is in Rome. However, the Vatican City State recognizes the Republic of China (ROC, which controls Taiwan) and as such, the ROC Embassy to the Holy See is also in Rome.