The 22-year-old came up through the ranks of the Blues' youth system but failed to cement his place in the first team. He was sent out on loan as he had temporary spells at with the Hornets, Nottingham Forest, Middlesbrough, Burnley, Reading and Napoli.
Chalobah stayed at Stamford Bridge after Antonio Conte was impressed with the player in the 2016 pre-season. He made 10 appearances in the league for the west London club and made his first start in the league against Watford in May.
The England Under-21 international had one year left on his contract and Chelsea were keen on retaining him. He joined Watford and agreed to a five-year deal. He will return to Vicarage Road this summer.
A statement on Watford's official website read, "Nathaniel Chalobah has sealed a permanent return to Watford from Chelsea, the Hornets are delighted to confirm. The England Under-21 international midfielder has signed a five-year deal at Vicarage Road and joins for an undisclosed fee."
Chalobah represented England on 97 times across various youth levels. His departure is unlikely to make a massive impact for the Premier League winners as he did not feature regularly for the London club last term.
The Daily Mail claims the English midfielder was also wanted by Southampton and Swansea City. However, he snubbed advances from the other Premier League clubs as he wanted to return to Watford where he spent the 2012/13 season on loan.
He will be wearing the No 14 shirt for Watford, who will kick-start their season under the guidance of their new manager Marco Silva. The Hornets sacked Walter Mazzarri and replaced him with Silva, who left his position at Hull City after they were relegated from the Premier League.