Many of the major pathways that govern early development in higher animals have been identified in cnidarians, including the Wnt, TGFbeta and tyrosine kinase signaling pathways. We show here that Notch signaling is also conserved in these early metazoans. We describe the Hydra Notch receptor (HvNotch) and provide evidence for the conservation of the Notch signaling mode via regulated intramembrane proteolysis. We observed that nuclear translocation of the Notch intracellular domain (NID) was inhibited by the synthetic gamma-secretase inhibitor DAPT. Moreover, DAPT treatment of hydra polyps caused distinct differentiation defects in their interstitial stem cell lineage. Nerve cell differentiation proceeded normally but post-mitotic nematocyte differentiation was dramatically reduced. Early female germ cell differentiation was inhibited before exit from mitosis. From these results we conclude that gamma-secretase activity and presumably Notch signaling are required to control differentiation events in the interstitial cell lineage of Hydra.