Fungal bioluminescence was recently shown to depend on a unique oxygen-dependent system of several enzymes. However, the identities of the enzymes did not reveal the full biochemical details of this process, as the enzymes do not bear resemblance to those of other luminescence systems, and thus the properties of the enzymes involved in this fascinating process are still unknown. Here, we describe the characterization of the penultimate enzyme in the pathway, hispidin 3-hydroxylase, from the luminescent fungus Mycena chlorophos (McH3H), which catalyzes the conversion of hispidin to 3-hydroxyhispidin. 3-Hydroxyhispidin acts as a luciferin substrate in luminescent fungi. McH3H was heterologously expressed in Escherichia coli and purified by affinity chromatography with a yield of 100 mg/liter. McH3H was found to be a single component monomeric NAD(P)H-dependent FAD-containing monooxygenase having a preference for NADPH. Through site-directed mutagenesis, based on a modeled structure, mutant enzymes were created that are more efficient with NADH. Except for identifying the residues that tune cofactor specificity, these engineered variants may also help in developing new hispidin-based bioluminescence applications. We confirmed that addition of hispidin to McH3H led to the formation of 3-hydroxyhispidin as sole aromatic product. Rapid kinetic analysis revealed that reduction of the flavin cofactor by NADPH is boosted by hispidin binding by nearly 100-fold. Similar to other class A flavoprotein hydroxylases, McH3H did not form a stable hydroperoxyflavin intermediate. These data suggest a mechanism by which the hydroxylase is tuned for converting hispidin into the fungal luciferin.