Fatty acid binding proteins (FABPs) are a family of intracellular lipid chaperone proteins known to play critical roles in the regulation of fatty acid uptake and transport as well as gene expression. Brain-type fatty acid binding protein (FABP7) is enriched in astrocytes and has been implicated in sleep/wake regulation and neurodegenerative diseases; however, the precise mechanisms underlying the role of FABP7 in these biological processes remain unclear. FABP7 binds to both arachidonic acid (AA) and docosahexaenoic acid (DHA), resulting in discrete physiological responses. Here, we propose a dichotomous role for FABP7 in which ligand type determines the subcellular translocation of fatty acids, either promoting wakefulness aligned with Alzheimer’s pathogenesis or promoting sleep with concomitant activation of anti-inflammatory pathways and neuroprotection. We hypothesize that FABP7-mediated translocation of AA to the endoplasmic reticulum of astrocytes increases astrogliosis, impedes glutamatergic uptake, and enhances wakefulness and inflammatory pathways via COX-2 dependent generation of pro-inflammatory prostaglandins. Conversely, we propose that FABP7-mediated translocation of DHA to the nucleus stabilizes astrocyte-neuron lactate shuttle dynamics, preserves glutamatergic uptake, and promotes sleep by activating anti-inflammatory pathways through the peroxisome proliferator-activated receptor-γ transcriptional cascade. Importantly, this model generates several testable hypotheses applicable to other neurodegenerative diseases, including amyotrophic lateral sclerosis and Parkinson’s disease.