Inhibitory neurotransmission mediated by GABAA receptors can be modulated by the endogenous neurosteroids, allopregnanolone and tetrahydro-deoxycorticosterone. Neurosteroids are synthesized de novo in the brain during stress, pregnancyand after ethanol consumption, and disrupted steroid regulation of GABAergic transmission is strongly implicated in several debilitating conditions such as panic disorder, major depression, schizophrenia, alcohol dependence and catamenial epilepsy. Determining how neurosteroids interact with the GABAA receptor is a prerequisite for understanding their physiological and pathophysiological roles in the brain. Here we identify two discrete binding sites in the receptor's transmembrane domains that mediate the potentiating and direct activation effects of neurosteroids. They potentiate GABA responses from a cavity formed by the α-subunit transmembrane domains, whereas direct receptor activation is initiated by interfacial residues between α and β subunits and is enhanced by steroid binding to the potentiation site. Thus, significant receptor activation by neurosteroids relies on occupancy of both the activation and potentiation sites. These sites are highly conserved throughout the GABAA receptor family, and their identification provides a unique opportunity for the development of new therapeutic, neurosteroid-based ligands and transgenic disease models of neurosteroid dysfunction.