The Iran blog "Keeping The Change" reports:
[P]aint balls not only may be being used to disperse the crowds, but also that a more nefarious strategy may lie behind the tactic. According to this person, the security forces use these paint balls to single out protestors, who they believe should be arrested. Sharp shooters are positioned in nearby locations (where they cannot be seen by the demonstrators) and launch paint balls at selected targets, leaving colored paint on these individuals' clothes. The plainclothes policemen who regularly mix in with the crowds of protestors then identify these targeted demonstrators by the paint on their clothing, arresting them on the spot.
The blog also claims - though unverified - that some of the ammunition is coming from Pev's Paintball, a chain of superstores based in the US.