In a small bowl, whisk together the water and yeast. Set aside for about 4 minutes, or until bubbles form.
In a medium bowl, whisk together the milk, egg, sugar, salt, vanilla, baking powder and butter. Whisk in the yeast mixture.
Sift in the flour a little at a time, and stir with a spoon until a soft ball forms that isn’t sticky on the outside.
Turn the dough out onto a floured surface and sprinkle lightly with flour. Knead for 2 to 3 minutes. Place the dough in a greased bowl, cover with a towel and let rise for about 2 hours, or until doubled in size.
Roll the dough out onto a floured surface to about ¼- inch thick. Cut the dough into roughly 2 inch squares. Cover with a towel and let rest 5 minutes.
Preheat the oil in a Dutch oven or deep fryer to 330 to 340 degrees F. Lightly pat down the dough squares then place the dough in the oil, a few at a time, and fry until they are golden brown. Strain from the oil and place on a wire rack. Sprinkle with powdered sugar and serve warm or at room temperature.