The substrate activity screening (SAS) method, a substrate-based fragment identification and optimization method for the development of enzyme inhibitors, was previously applied to cathepsin S to obtain a novel (2-arylphenoxy)acetaldehyde inhibitor, 2, with a 0.49 microM Ki value (Wood, W. J. L.; Patterson, A. W.; Tsuruoka, H.; Jain, R. K.; Ellman, J. A. J. Am. Chem. Soc. 2005, 127, 15521-15527). In this paper we disclose the X-ray structure of a complex between cathepsin S and inhibitor 2 which reveals an unprecedented binding mode. On the basis of this structure, additional 2-biaryloxy substrates with greatly increased cleavage efficiency were designed. Conversion of the optimized substrates to the corresponding aldehyde inhibitors yielded a low molecular weight (304 Daltons) and potent (9.6 nM) cathepsin S inhibitor that showed from 100- to >1000-fold selectivity relative to cathepsins B, L, and K.