As a step toward the elucidation of mechanisms in vesicle budding, a cell-free assay that measures cytosol-induced vesicle generation from liposomes was established. This assay then was used to explore the role of phosphoinositides in vesicle formation. Liposomes incubated with brain cytosol in the presence of ATP and GTP massively generated small vesicles, as assessed both quantitatively and qualitatively by a dynamic light-scattering assay. Both ATP and GTP were required. Vesicle formation was inhibited greatly by the immunodepletion of dynamin 1 from the cytosol, indicating a major contribution of this GTPase in this reaction and suggesting that it mimics endocytic vesicle fission. Increasing the concentration Of L-alpha-phosphatidylinositol 4,5-bisphosphate [PtdIns(4,5)P-2] but not of L-alpha-phosphatidylinositol 4-monophosphate or L-alpha-phosphatidylinositol in the lipid membranes enhanced vesicle formation. Lipid analysis revealed rapid degradation of PtdIns(4,5)P-2 to L-alpha-phosphatidylinositol during the incubation with the reaction reaching a maximum within 5 sec, whereas vesicle formation proceeded with a longer time course. PtdIns(4,5)P-2 degradation was independent of vesicle formation and occurred also in the presence of guanosine 5'-O-(thiotriphosphate), where few vesicle formations occurred. These results suggest that PtdIns(4,5)P-2 plays a critical role in the early step of vesicle formation, possibly in the recruitment of coats and fission factors to membranes.