Synovial joints and articular cartilage play crucial roles in the skeletal function, but relatively little is actually known about their embryonic development. Here we first focused on the interzone, a thin mesenchymal cell layer forming at future joint sites that is widely thought to be critical for joint and articular cartilage development. To determine interzone cell origin and fate, we microinjected the vital fluorescent dye DiI at several peri-joint sites in chick limbs and monitored the behavior and fate of labeled cells over time. Peri-joint mesenchymal cells located immediately adjacent to incipient joints migrated, became part of the interzone, and were eventually found in epiphyseal articular layer and joint capsule. Interzone cells isolated and reared in vitro expressed typical phenotypic markers, including GDF-5, Wnt-14, and CD-44, and differentiated into chondrocytes over time. To determine the molecular mechanisms of articular chondrocyte formation, we carried out additional studies on the ets transcription factor family member ERG and its alternatively spliced variant C-1-1 that we previously found to be expressed in developing avian articular chondrocytes. We cloned the human counterpart of avian C-1-1 (ERGp55Delta81) and conditionally expressed it in transgenic mice under cartilage-specific Col2 gene promotor-enhancer control. The entire transgenic mouse limb chondrocyte population exhibited an immature articular-like phenotype and a virtual lack of growth plate formation and chondrocyte maturation compared to wild-type littermate. Together, our studies reveal that peri-joint mesenchymal cells take part in interzone and articular layer formation, interzone cells can differentiate into chondrocytes, and acquisition of a permanent articular chondrocyte phenotype is aided and perhaps dictated by ets transcription factor ERG.