A state-based approach for online passive fault diagnosis in systems modeled as finite-state automata is presented. In this framework, the system and the diagnoser (the fault detection system) do not have to be initialized at the same time. Furthermore, no information about the state or even the condition (failure status) of the system before the initiation of diagnosis is required. The design of the fault detection system, in the worst case, has exponential complexity. A model reduction scheme with polynomial time complexity is introduced to reduce the computational complexity of the design. Diagnosability of failures is studied, and necessary and sufficient conditions for failure diagnosability are derived.