Recent progress in psycholinguistic research on written Chinese allows us to develop a new approach to investigate the Chinese reading acquisition process. We hypothesized that Chinese children, much like children learning an alphabetic script, do not simply learn written words by rote. As they are taught words to be learned by rote, they develop an implicit understanding of the formal and functional characteristics of written Chinese. The formal characteristics refer to the graphic structure and the positioning of the stroke-patterns, and the functional characteristics refer to the semantic and phonological information conveyed in the stroke-patterns. The studies reported were designed to investigate the nature of children's learning of written Chinese. In two series of studies, a total of 236 children from Hong Kong, aged four to nine, created and decoded novel Chinese compound words. Results showed that young Chinese children attended to both the formal and functional constraints in reading and writing tasks. In the judging task, 4-year-olds were able to identify the type of orthographic elements - the stroke-patterns, but they could not place them in legitimate positions. The 6-years-olds were able to refer both to the position and the correct type of orthographic elements in differentiating pseudowords from nonwords. In the writing and reading tasks, four and five-year-olds were unable to utilize the semantic radicals to represent meaning, nor could they use the phonological components for pronunciation; six-year-olds could use the semantic radicals to represent meaning and only nine-year-olds could both use semantic radicals correctly and systematically referred to the phonological components for pronunciation. A significant age difference was found in all the experiments. The studies provide strong evidence that learning compound words in Chinese is not a simple matter of memorizing but involves the understanding of formal and functional constraints in the script. A possible application of these findings lies in the new direction offered for reading instruction where the non-generative, rote view of learning to read and write in Chinese can be safely abandoned.