Sitting on the comfy sofa on the top floor of MediaLab Europe's Dublin headquarters playing "Mindgames" - one of the research institute's flagship projects - feels like hanging out in a penthouse suite of the future.

The view of the city from the laboratory, which is housed in a 19th century building that was formerly part of the Guinness brewery, is stunning. And the vast array of high-tech gadgets and powerful computers look like they can provide hours of fun for the technology literate visitor.

Mindgames is the creation of Mr Gary McDarby and a team of other researchers at MediaLab Europe who have created a video game and a range of sensor technologies that are designed to measure brain activity to help people control stress levels.

The technology is one of a handful of MediaLab Europe projects that have been adopted - at least on a pilot basis - in the real world. The Mater Hospital used the technology recently to help children suffering from stress to train themselves to relax better.

Unfortunately, stress levels among MediaLab Europe's management and its principal backers, the Government and the Massachusetts Institute of Technology (MIT), are rising fast.

Results published by MediaLab Europe last week show that it faces a major funding shortfall next year because of its failure to attract enough corporate sponsorship since its launch in 2000. The laboratory, which has received €35 million State funding, spent €5.6 million more than it raised in funding during 2003, and has told the Government that it will not be able to achieve its original goal of becoming self-sustaining anytime soon. It has also asked the State for bridging finance worth €10 million to cover costs.

MediaLab Europe is the product of a 10-year collaboration between the Government and MIT agreed in 2000 and, like the original MediaLab organisation in Boston, its business model is based on corporate sponsorship.

Orange, the BBC and Eircom have all supported the European arm which, unlike a standard university, mixes specialist researchers from different backgrounds on projects and acts as a kind of hybrid between the corporate and academic worlds.

But the three-year downturn in the technology sector is threatening its future and the State's ambitious plan to develop a "digital village" in the Liberties area.

"We can confirm that we have held discussions with the Government about the funding issue and that the State is in discussion with MIT," says Mr John Callinan, MediaLab Europe's chief operating officer, who refuses to offer any detail on these talks.

But he says MediaLab Europe is seeking funding from several other sources to fill a shorfall in corporate funding, which is currently running at about €2 million compared to the €10 million envisaged in its business plan.

Late last year, the laboratory signed its first deal with a State agency, the Highlands and Islands Enterprise network in Scotland, and it is seeking to replicate this model as a means to tap into extra funding. It is also pursuing research grants from the European Union and has held initial talks with the European Commission in an attempt to influence the way it funds research.

But there is an acknowledgment among all parties connected with MediaLab Europe that its business model, which was conceived during the hype of the dotcom era, was unrealistic.

"The laboratory was conceived at the height of the boom and born into a period of recession," says Mr Callinan. "It is incredibly difficult to raise corporate funding, although there are signs things are improving."

Warning signs were clearly visible over the past two years as an MIT pilot project in Asia conceived with the Indian government, MediaLab Asia, folded after a year of operation.

The original MIT MediaLab in Boston has also been forced to cut back its own grand ambitions and restructure its operations because of a shortfall of funding.

As one technology industry veteran said yesterday, companies have consciously refocused their research to concentrate on more tangible projects that can produce a profit. In this environment institutions like MediaLab, which does not allow its corporate donors to dictate research activity, are falling out of favour.

There is little doubt that the Government was well aware of the risks associated with bringing the flagship MediaLab Europe project to Ireland. Documents released under the Freedom of Information Act to The Irish Times show that it allocated €35 million in funding to the project in 2000 despite being warned that "there would be an expectation that the State would fund the ongoing operation of MediaLab Europe should corporate sponsorship fail to materialise on the scale projected".

This memo, which was written by the then assistant secretary of the Taoiseach's department, Mr Dermot McCarthy, was stamped as "seen by the Taoiseach", who is a key supporter of the MediaLab and Digital Hub projects.

Despite the warnings, the funding was allocated on the basis that no Irish institution could provide the expertise or international brand name of MIT - at least not in the short term.

The State has so far remained tight-lipped about whether it will supply the financing to keep the laboratory afloat. A spokesman for the Department of Communications confirmed yesterday the State was in talks with MIT about the funding model for the centre.

The Taoiseach's connection with MediaLab Europe should stand it in good stead. But other Ministers in Cabinet, such as the former Minister for Education, Mr Michael Martin, have warned in the past about giving so much money to an overseas institution.

Dr Danny O'Hare, the Government's appointed director on the MediaLab Europe board, says the State should provide ongoing support to the laboratory in the same way it funds Irish universities.

"MediaLab offers a very different way of looking at research and acts as a bridge between basic research and the normal focused research by companies," he says.

"It is futuristic, perhaps beyond basic research and it looks beyond where technology is at the moment... It helps to convince the international community that we are serious about doing cutting edge research."