Using an electric mixer, cream the peanut butter and two cups of the powdered sugar until smooth. Add the rice cereal, butter, and chopped peanuts. Shape into balls. (You decide the size.)
Mix the water and vanilla with the remaining cup of powdered sugar to make the icing. Put the coconut into a shallow dish. Dip the balls into the icing and then into the coconut. Let them dry on a wire rack.