AMSH, a deubiquitinating enzyme (DUB) with exquisite specificity for Lys63-linked polyubiquitin chains, is an endosome-associated DUB that regulates sorting of activated cell-surface signaling receptors to the lysosome, a process mediated by the members of the endosomal sorting complexes required for transport (ESCRT) machinery. Whole-exome sequencing of DNA samples from children with microcephaly capillary malformation (MIC-CAP) syndrome identified recessive mutations encoded in the AMSH gene causatively linked to the disease. Herein, we report a number of important observations that significantly advance our understanding of AMSH within the context of the ESCRT machinery. First, we performed mutational and kinetic analysis of the putative residues involved in diubiquitin recognition and catalysis with a view of better understanding the catalytic mechanism of AMSH. Our mutational and kinetic analysis reveals that recognition of the proximal ubiquitin is imperative for the linkage specificity and catalytic efficiency of the enzyme. The MIC-CAP disease mutation, Thr313Ile, yields a substantial loss of catalytic activity without any significant change in the thermodynamic stability of the protein, indicating that its perturbed catalytic activity is the basis of the disease. The catalytic activity of AMSH is stimulated upon binding to the ESCRT-0 member STAM; however, the precise mechanism and its significance are not known. On the basis of a number of biochemical and biophysical analyses, we are able to propose a model for activation according to which activation of AMSH is allowed by facile, simultaneous binding to two ubiquitin groups in a polyubiquitin substrate, one by the catalytic domain of the DUB (binding to the distal ubiquitin) and the other (the proximal ubiquitin) by the ubiquitin interacting motif (UIM) from STAM. Such a mode of binding would stabilize the ubiquitin chain in a productive orientation, resulting in an enhancement of the activity of the enzyme. These data together provide a mechanism for understanding the recruitment and activation of AMSH at ESCRT-0, providing biochemical and biophysical evidence that supports a role for AMSH when it is recruited to the initial ESCRT complex: it functions to facilitate the transfer of ubiquitinated receptors (cargo) from one ESCRT member to the next by disassembling the polyubiquitin chain while leaving some ubiquitin groups still attached to the cargo.