The Hedgehog (Hh) signaling pathway plays important roles in developmental processes including pattern formation and tissue homeostasis. The seven-pass transmembrane receptor Smoothened (Smo) is the pivotal transducer in the pathway; it, and thus the pathway overall, is regulated by ubiquitin-mediated degradation, which occurs in the absence of Hh. In the presence of Hh, the ubiquitination levels of Smo are decreased, but the molecular basis for this outcome is not well understood. Here, we identify the deubiquitinase UCHL5 as a positive regulator of the Hh pathway. We provide both genetic and biochemical evidence that UCHL5 interacts with and deubiquitinates Smo, increasing stability and promoting accumulation at the cell membrane. Strikingly, we find that Hh enhances the interaction between UCHL5 and Smo, thereby stabilizing Smo. We also find that proteasome subunit RPN13, an activator of UCHL5, could enhance the effect of UCHL5 on Smo protein level. More importantly, we find that the mammalian counterpart of UCHL5, UCH37, plays the same role in the regulation of Hh signaling by modulating hSmo ubiquitination and stability. Our findings thus identify UCHL5/UCH37 as a critical regulator of Hh signaling and potential therapeutic target for cancers.