does this only work if both parties have @protonmail.com ?

It works seamlessly/automatically between protonmail users and you can also send encrypted mail to non-protonmail users - they receive a link via email that they need a password to access.

You can also export your PGP public key and receive encrypted email from anyone else too.

I like Protonmail, but its a far cry away from 'real' GPG. They are just now adding SMTP. They don't allow key uploads. They don't let you send (gpg) encrypted E-Mail to non Protonmail users and there are some other problems.

I wish them a lot of luck fixing and working on this stuff.

Encryption works automatically, yes. You can also send encrypted emails to non-proton users that require a pin code to read.