This paper analyzes the problem of transformer differential protection. First, we review the concept of transformer differential protection. We then analyze magnetizing inrush, overexcitation, and current transformer (CT) saturation phenomena as possible causes of relay misoperation. Finally, we summarize the existing methods for discriminating internal faults from inrush and overexcitation conditions. In Part II of the paper, we propose a new approach for transformer differential protection and describe the relay that is based on this approach.Index Terms-Differential protection, power transformer protection, protective relaying.