The midfielder has been on loan with Barnsley and impressed Nigel Pearson by setting up two goals against the Foxes in his last outing for the Yorkshire outfit.
The opportunity to earn a permament deal at Championship level appealed to the 21-year-old after a fee was agreed between the two clubs.
"He's been absolutely superb," commented Barnsley boss Keith Hill to the Sheffield Star. "I believe he will be a Premier League player one day."
City boss Pearson, who worked with plenty of former Reds during his time as Hull City manager, told the club's official website: "Danny is a young and hungry player and his ambitions match those of the club."
Drinkwater has signed a contract that will run until 2015.