We report a systematic analysis of the P1' and P2' substrate specificity of TNF-alpha converting enzyme (TACE) using a peptide library and a novel analytical method, and we use the substrate specificity information to design novel reverse hydroxamate inhibitors. Initial truncation studies, using the amino acid sequence around the cleavage site in precursor-TNF-alpha, showed that good turnover was obtained with the peptide DNP-LAQAVRSS-NH2. Based on this result, 1000 different peptide substrates of the form Biotin-LAQA-P1'-P2'-SSK(DNP)-NH2 were prepared, with 50 different natural and unnatural amino acids at P1' in combination with 20 different amino acids at P2'. The peptides were pooled, treated with purified microsomal TACE, and the reaction mixtures were passed over a streptavidin affinity column to remove unreacted substrate and the N-terminal biotinylated product. C-terminal cleavage products not binding to streptavidin were subjected to liquid chromatography/mass spectrometry analysis where individual products were identified and semiquantitated. 25 of the substrates were resynthesized as discrete peptides and assayed with recombinant TACE. The experiments show that recombinant TACE prefers lipophilic amino acids at the P1' position, such as phenylglycine, homophenylalanine, leucine and valine. At the P2' position, TACE can accommodate basic amino acids, such as arginine and lysine, as well as certain non-basic amino acids such as citrulline, methionine sulfoxide and threonine. These substrate preferences were used in the design of novel reverse hydroxamate TACE inhibitors with phenethyl and 5-methyl-thiophene-methyl side-chains at P1', and threonine and nitro-arginine at P2'.