After the cellular prion protein (PrPC) transits to the cell surface where it is bound by a glycophosphatidyl inositol (GPI) anchor, PrPC is either metabolized or converted into the scrapie isoform (PrPSc). Because most GPI-anchored proteins are associated with cholesterol-rich membranous microdomains, we asked whether such structures participate in the metabolism of PrPC or the formation of PrPSc. The initial degradation of PrPC involves removal of the NH2 terminus of PrPC to produce a 17-kD polypeptide which was found in a Triton X-100 insoluble fraction. Both the formation of PrPSc and the initial degradation of PrPC were diminished by lovastatin-mediated depletion of cellular cholesterol but were insensitive to NH4Cl. Further degradation of the 17-kD polypeptide did occur within an NH4Cl-sensitive, acidic compartment. Replacing the GPI addition signal with the transmembrane and cytoplasmic domains of mouse CD4 rendered chimeric CD4PrPC soluble in cold Triton X-100. Both CD4PrPC and truncated PrPC without the GPI addition signal (Rogers, M., F. Yehieley, M. Scott, and S. B. Prusiner. 1993. Proc. Natl. Acad. Sci. USA. 90:3182-3186) were poor substrates for PrPSc formation. Thus, it seems likely that both the initial degradation of PrPC to the 17-kD polypeptide and the formation of PrPSc occur within a non-acidic compartment bound by cholesterol-rich membranes, possibly glycolipid-rich microdomains, where the metabolic fate of PrPC is determined. The pathway remains to be identified by which the 17-kD polypeptide and PrPSc are transported to an acidic compartment, presumably endosomes, where the 17-kD polypeptide is hydrolyzed and limited proteolysis of PrPSc produces PrP 27-30.