During gastrulation in amphibians, secreted factors from Spemann's organizer act on dorsal ectoderm to induce the central nervous system. A number of secreted factors produced by Spemann's organizer have recently been identified. The TGFbeta family member Xnr3 is similar in amino acid sequence to the mouse factor nodal and is expressed in a restricted group of cells in the superficial layer of Spemann's organizer. Xnr3, unlike the related factors nodal, Xnr1 and Xnr2, lacks mesoderm-inducing activity. We report here that Xnr3 can directly induce neural tissue in Xenopus ectoderm explants (animal caps). Injection of animal caps with either Xnr3 RNA or plasmids induces the expression of the pan-neural genes NCAM and nrp1, as well as the anterior neural marker Cpl1. A growing body of evidence suggests that neural induction in Xenopus proceeds as the default in the absence of epidermis inducers. The best candidates for the endogenous epidermis inducers are BMP-4 and BMP-7. The neural inducing activity of Xnr3 can be inhibited by overexpression of BMP-4, as has been observed with the neural inducers noggin, chordin and follistatin. Furthermore, Xnr3 can block mesoderm induction by BMP-4 and activin, but not by Xnr2. The structural basis underlying the divergent activities of Xnr2 and Xnr3 was analyzed using site-directed mutagenesis. Mutations introduced to the conserved cysteine residues characteristic of the TGFbeta family were found to inactivate Xnr2, but not Xnr3. The most unique feature of Xnr3 is the absence of a conserved cysteine at the C terminus of the protein. This feature distinguishes Xnr3 from other TGFbeta family members, including Xnr2. However, we observed that changing the C terminus of Xnr3 to more closely resemble other TGFbeta family members did not significantly alter its activity, suggesting that other structural features of Xnr3 distinguish its biological activity from Xnr2.