Discovering the molecular mechanisms that regulate neuron-specific gene expression remains a central challenge for CNS research. Here, we report that small, non-coding double-stranded (ds) RNAs play a critical role in mediating neuronal differentiation. The sequence defined by this dsRNA is NRSE/RE1, which is recognized by NRSF/REST, known primarily as a negative transcriptional regulator that restricts neuronal gene expression to neurons. The NRSE dsRNA can trigger gene expression of neuron-specific genes through interaction with NRSF/REST transcriptional machinery, resulting in the transition from neural stem cells with neuron-specific genes silenced by NRSF/REST into cells with neuronal identity that can express neuronal genes. The mechanism of action appears to be mediated through a dsRNA/protein interaction, rather than through siRNA or miRNA. The discovery of small modulatory dsRNAs (smRNAs) extends the important contribution of non-coding RNAs as key regulators of cell behavior at both transcriptional and post-transcriptional levels.