Cream together thoroughly butter and sugar.
Sift flour, measure, and sift with the baking powder, and salt.
Add dry ingredients to creamed mixture alternately with milk combined with vanilla beginning and ending with dry ingredients.
After each addition beat until smooth.
Finely grate chocolate.
Blend into batter.
Beat egg whites until foamy; add the 1/2 cup sugar, a tablespoon at a time; beat until stiff.
Carefully fold into batter.
Pour into three 8-inch round layer cake pans, or two 9-inch pans, greased and floured.
Bake in a moderate oven (350°) for 20 to 25 minutes, or until toothpick inserted in center comes out clean.
Cool slightly.
Turn layers out of pans; cool thoroughly on wire racks.
Frost between layers and on top and sides with this frosting: Beat together butter and egg yolks.
Blend powdered sugar into butter and egg mixture until smooth.
Melt chocolate chips in top part of double boiler.
Add water and stir until smooth.
Pour over top of cake, allowing a small amount to drip down sides of cake.