Diabetic sensory neuropathy (DSN) is one of the most common complications of type 2 diabetes (T2D), however the molecular mechanistic association between T2D and DSN remains elusive. Here we identify ubiquitin C-terminal hydrolase L1 (UCHL1), a deubiquitinase highly expressed in neurons, as a key molecule underlying T2D and DSN. Genetic ablation of UCHL1 leads to neuronal insulin resistance and T2D-related symptoms in Drosophila. Furthermore, loss of UCHL1 induces DSN-like phenotypes, including numbness to external noxious stimuli and axonal degeneration of sensory neurons in flies’ legs. Conversely, UCHL1 overexpression improves DSN-like defects of T2D model flies. UCHL1 governs insulin signaling by deubiquitinating insulin receptor substrate 1 (IRS1) and antagonizes an E3 ligase of IRS1, Cullin 1 (CUL1). Consistent with these results, genetic and pharmacological suppression of CUL1 activity rescues T2D- and DSN-associated phenotypes. Therefore, our findings suggest a complete set of genetic factors explaining T2D and DSN, together with potential remedies for the diseases.