Human embryonic stem cells (hESCs) provide a unique resource to analyze early stages of human hematopoiesis. However, little is known about the ability to use hESCs to evaluate lymphocyte development. In the present study, we use a two-step culture method to demonstrate efficient generation of functional NK cells from hESCs. The CD56+ CD45+ hESC-derived lymphocytes express inhibitory and activating receptors typical of mature NK cells, including killer cell Ig-like receptors, natural cytotoxicity receptors, and CD16. Limiting dilution analysis suggests that these cells can be produced from hESC-derived hemopoietic progenitors at a clonal frequency similar to CD34+ cells isolated from cord blood. The hESC-derived NK cells acquire the ability to lyse human tumor cells by both direct cell-mediated cytotoxicity and Ab-dependent cellular cytotoxicity. Additionally, activated hESC-derived NK cells up-regulate cytokine production. hESC-derived lymphoid progenitors provide a novel means to characterize specific cellular and molecular mechanisms that lead to development of specific human lymphocyte populations. These cells may also provide a source for innovative cellular immune therapies.