The former Grimsby man was due to be out of contract in the summer, but has now put pen to paper on a deal that goes through until 2010.
The right-back has not been a regular this season - but the departure of loan signing John Halls should see his first-team chances bolstered.
Butterfield told the official site: "I am delighted to be signing a new deal with the club and believe the current squad can challenge for honours at the end of the season.
"This was an important decision for me at this time of my career and I would like to thank the fans for always making me so welcome at Palace."