Notch signaling regulates cell fate decisions during development through local cell interactions. Signaling is triggered by the interaction of the Notch receptor with its transmembrane ligands expressed on adjacent cells. Recent studies suggest that Delta is cleaved to release an extracellular fragment, DlEC, by a mechanism that involves the activity of the metalloprotease Kuzbanian; however, the functional significance of that cleavage remains controversial. Using independent functional assays in vitro and in vivo, we examined the biological activity of purified soluble Delta forms and conclude that Delta cleavage is an important down-regulating event in Notch signaling. The data support a model whereby Delta inactivation is essential for providing the critical ligand/receptor expression differential between neighboring cells in order to distinguish the signaling versus the receiving partner.