The cellular toxicity of nanoparticles that were capped with a bilayered ligand was studied using an up-converting (UC) phosphor material as a representative nanoparticle (NP). The results indicate that although UC NPs are known to be nontoxic, the toxicity of the NPs depends strongly on ligand coordination conditions, in addition to the other commonly known parameters such as size, structure, surface charge etc. Oleate-capped hydrophobic NaYF4:Yb,Er NPs were surface modified to yield three extreme conditions: bare particles that were stripped of the oleate ligands; particles with covalently bound poly(ethylene glycol) (PEG) ligands; and particles with an bilayer of PEG-oleate ligands using the oleate surface group that was remained after synthesis. It was found that the bare particles and the covalent PEG NPs induced little toxicity. However, particles that were rendered biocompatible by forming a bilayer with an amphiphilic ligand (i.e., PEG-oleate) resulted in significant cell toxicity. These findings strongly suggest that the PEG-oleate group dissociated from the bilayered oleate-capped NPs, resulting in significant toxicity by exposing the hydrophobic oleate-capped NPs to the cell. Based on results with bare particles, the NaLnF4:Yb,Er (Ln = Y, Gd) up-converting phosphors are essentially less-toxic. Capping and functionalizing these particles with ligand intercalation may, however, not be a suitable method for rendering the NPs suitable for bioapplication as the ligand can potentially dissociate upon cellular interaction, leading to significant toxicity.