An official who tested the product for a government agency said that it would link PCs with an updated database of banned websites and block access to those addresses.
A foreign industry official who examined Green Dam told the Wall Street Journal that the software would also transmit personal information to the authorities and that it would be difficult for users to tell exactly what was being blocked.
Susan Stevenson, a spokeswoman for the US embassy in Beijing, said the US was studying the new rule to "assess its impact".
"We would view any attempt to restrict the free flow of information with great concern and as incompatible with China's aspirations to build a modern, information-based economy and society," she said.
Francis Moriarty, a member of the press freedom committee of the Hong Kong Foreign Correspondents Club, told Al Jazeera that the move is "another brick in the Chinese censorship wall".
"I'm aware that the government says it is aimed at pornographic websites, but it also has the ability to block other websites, too," he said.
The software was developed by Jinhui Computer System Engineering Company, with assistance from the Beijing Dazheng Human Language Technology Academy.
|China is home to the world's largest online population [GALLO/GETTY]
Both companies are linked to China's military and security ministries.
The moves comes as Chinese authorities blocked access to social networking website Twitter and several other internet services last week, as a measure ahead of the twentieth anniversary of the crackdown on the Tiananmen Square democracy protests.
Twitter, Flickr, the online photo sharing service, and Microsoft's free email service Hotmail, were blocked or subject to disruption.
China, home to the world's largest online population, routinely blocks access to sites it deems potentially subversive at sensitive times.