Butterfield, 28, is eager to kick-start his career again after falling out of favour at Derby, where he has not featured under Rams chief Frank Lampard.
Butterfield spent much of last term on loan at Sheffield Wednesday, having previously played in Yorkshire for Barnsley, Huddersfield Town and Middlesbrough.
The midfielder is out of contract in the summer with Bradford understood to paying a fair portion of his wages.
He said: "I am delighted to be here, joining my hometown club. When it came to signing for a League One team, Bradford was my first choice.
"I am looking forward to the challenges ahead. This is a massive club, one I know very well, and hopefully I can have a positive influence and really add to the squad.
"Playing in front of the home crowd will be a great feeling. It has always been something I have had in the back of my mind - that I would love to play for Bradford at some point.
"I have friends and family who support the club, so it is certainly an interesting one for me to come and play here.
"I want to make an impact straight away. There is a great deal of quality and, in recent weeks, the team has been in good form."