Twisted gastrulation (TSG) is an extracellular modulator of bone morphogenetic protein (BMP) activity and regulates dorsoventral axis formation in early Drosophila and Xenopus development. Studies on tsg-deficient mice also indicated a role of this protein in skeletal growth, but the mechanism of TSG activity in this process has not yet been investigated. Here we show for the first time by in situ hybridization and immunohistochemistry that TSG is strongly expressed in bovine and mouse growth plate cartilage as well as in fetal ribs, vertebral cartilage, and cartilage anlagen of the skull. Furthermore we provide evidence that TSG is directly involved in BMP-regulated chondrocyte differentiation and maturation. In vitro, TSG impaired the dose-dependent BMP-2 stimulation of collagen II and X expression in cultures of MC615 chondrocytes and primary mouse chondrocytes. In the presence of chordin, a BMP antagonist, the inhibitory effect of TSG was further enhanced. TSG also inhibited BMP-2-stimulated phosphorylation of Smad factors in chondrocytes, confirming the role of TSG as a modulator of BMP signaling. For analysis of TSG functions in cartilage development in vivo, the gene was overexpressed in transgenic mice under the control of the cartilage-specific Col2a1 promoter. As a result, Col10a1 expression was significantly reduced in the growth plates of transgenic embryos and newborns in comparison with wild type littermates as shown by in situ hybridization and by real time PCR analysis. The data suggest that TSG is an important modulator of BMP-regulated cartilage development and chondrocyte differentiation.