The Walled-Off Hotel in Bethlehem is only four metres (yards) from the controversial wall which cuts through the occupied West Bank, and all the rooms face it.
The nine rooms, which Banksy described as having the "worst view of any hotel in the world," range from $30 for a bunk bed in one room to $965 per night for the presidential suite.
Guests, who will each put down a $1,000 deposit to ward off theft of the dozens of new Banksy works on the walls, began arriving in the early afternoon.
Paul Smith from the British city of Bristol, where Banksy is also said to be from, said he flew in especially to visit the hotel.
"It's bizarre -- I feel like I am in a painting."
He said he didn't much care for some of Banksy's recent work but was excited by this project.
"I feel like this means something -- coming here and making the effort and putting something into the economy."
Toan Nguyen from Australia said he waited a long time online to get a bed.
"I was in Israel for the last three weeks and by chance I heard about the hotel," he said.
Manager Wissam Salsaa said they were nearly totally booked for the next three months.
"We have arrivals today from six different countries, and I think most of our clients are flying just to stay here," he told AFP.
He rejected criticism the prices were unaffordable for many Palestinians, saying they had nearly 50 staff to pay and any profits would go back into the community.
"Everyone that came here thinks this is the most amazing project for letting the voice of the Palestinians be heard."
The hotel was announced unexpectedly at the beginning of the month and the artwork, Banksy's largest new collection in years, has been donated to the local community, the hotel's website says.
The artist closely protects his identity and was not in attendance at the launch.
Elton John played by video link at a launch party for staff and local residents.
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The West Bank wall is one of the most striking symbols of Israel's 50-year occupation, and has become a major focus for demonstrations and artwork -- including by Banksy.
Israel refers to it as the security barrier and insists it is crucial for keeping out would-be attackers, but an advisory opinion by the International Court of Justice declared it illegal in 2004.
The hotel's website encourages guests to explore the possibility of painting on the wall, while a graffiti supplies store with "everything you need to make your mark" was preparing to open next door this week.
In the hotel, staff in red waistcoats served Walled-Off Salads and afternoon tea in the lobby, while a self-playing piano performed classic pop hits.
Tourists are allowed to visit even if not staying, with a few mulling around inspecting a gallery selling Palestinian art and a museum highlighting the history of the region.
Bea Kaufmann, a German living in the Israeli commercial capital Tel Aviv, said she had come with friends as she thinks it is "important to see the other side" of the conflict.
The rooms themselves have a deliberate faded luxury, with typical Banksy touches.
Above a bed in one room, an Israeli soldier and Palestinian protester fight with pillows, while a television supposedly showing CNN is cracked and backwards.
In the presidential suite, a working jacuzzi is fed from a leaking water tank similar to those that adorn the roofs of many Palestinian homes.
Long history in territories
Banksy has a long history in the Palestinian territories.
In February 2015, he allegedly sneaked into the Gaza Strip through a smuggling tunnel and painted three works on the walls of Gaza homes destroyed in Israeli air strikes during the previous year's conflict.
In 2007, he painted a number of artworks in the West Bank town of Bethlehem, including a young girl frisking an Israeli soldier pinned up against a wall.
In 2005, he sprayed nine stencilled images at different locations along the eight-metre-high (27-foot) wall.
They included a ladder reaching over the wall, a young girl being carried over it by balloons and a window on the grey concrete showing beautiful mountains in the background.
His works, like elsewhere in the world, have become tourist attractions.