Protein tyrosine phosphatases (PTPs) form a large family of enzymes that serve as key regulatory components in signal transduction pathways. Defective or inappropriate regulation of PTP activity leads to aberrant tyrosine phosphorylation, which contributes to the development of many human diseases. In addition to controlling the phosphorylation states of protein kinase substrates, PTPs can also directly modulate protein kinase activity. Evidence suggests that PTPs can exert both positive and negative effects on a signaling pathway. Thus, further understanding of the fundamental role of protein tyrosine phosphorylation in complex and critical signal transduction pathways requires detailed studies of both the kinases and the phosphatases. In this review, we first summarize our current understanding of PTP structure and function. We then discuss the molecular basis of PTP substrate specificity, focusing primarily on mitogen-activated protein (MAP) kinase phosphatase 3. We demonstrate that the MAP kinase phosphatases display exquisite substrate specificity requiring extensive protein-protein interactions for precise down-regulation of MAP kinase activity. We also highlight our recent progress in developing small molecule PTP1B inhibitors. Using a novel combinatorial approach that is designed to target both the active site and a unique peripheral site in PTP1B, we have obtained a PTP1B inhibitor with 2.4 nM affinity and orders of magnitude selectivity against a panel of PTPs. Currently, some of the compounds are being evaluated in both cell and animal models to further define the role of PTP1B in insulin signaling.