Protein tyrosine phosphatases (PTPs) are a large family of enzymes that catalyze the hydrolytic removal of the phosphoryl group from phosphotyrosyl (pY) proteins. To date, the in vivo substrates and physiological functions of PTPs remain poorly defined. In this work, we have developed a novel combinatorial library method to systematically determine the substrate specificity of PTPs. A one-bead-one-compound peptide library containing five randomized residues, Fmoc-XXXXXpYAA (where X is norleucine or 17 proteinogenic amino acids excluding Tyr, Cys, and Met), was chemically synthesized on 90-mu m TentaGel resin by the split-and-pool method. Limited treatment of the library with a PTP removed the phosphoryl group from beads that carry the most preferred substrates. The exposed tyrosine side chain was selectively oxidized into an orthoquinone by the treatment with tyrosinase in the presence of atmospheric oxygen. The orthoquinone was then selectively derivatized with biotin-hydrazide, followed by on-bead colorimetric assay. The positive beads were isolated and individually sequenced by partial Edman degradation/mass spectrometry to give the most preferred substrates of the PTP. Screening of the pY library against PTP1B confirmed the previously reported PTP1B specificity, but also revealed a second class of previously unrecognized peptide substrates. Several selected peptides were individually synthesized and assayed against PTP1B and the kinetic data confirmed the screening results. This method is generally applicable to studying the substrate specificity of other PTPs.