In Xenopus embryos, β-catenin has been shown to be both necessary and sufficient for the establishment of dorsal cell fates. This signaling activity is thought to depend on the binding of β-catenin to members of the Lef/Tcf family of transcription factors and the regulation of gene expression by this complex. To test whether β-catenin must accumulate in nuclei to establish dorsal cell fate, we constructed various localization mutants that restrict β-catenin to either the plasma membrane, the cytosol, or the nucleus. When overexpressed in Xenopus embryos, the proteins localize as predicted, but surprisingly all forms induce an ectopic axis, indicative of inducing dorsal cell fates. Given this unexpected result, we focused on the membrane-tethered form of β-catenin to resolve the apparent discrepancy between its membrane localization and the hypothesized role of nuclear β-catenin in establishing dorsal cell fate. We demonstrate that overexpression of membrane-tethered β-catenin elevates the level of free endogenous β-catenin, which subsequently accumulates in nuclei. Consistent with the hypothesis that it is this pool of non–membrane-associated β-catenin that signals in the presence of membrane-tethered β-catenin, overexpression of cadherin, which binds free β-catenin, blocks the axis-inducing activity of membrane- tethered β-catenin. The mechanism by which ectopic membrane-tethered β-catenin increases the level of endogenous β-catenin likely involves competition for the adenomatous polyposis coli (APC) protein, which in other systems has been shown to play a role in degradation of β-catenin. Consistent with this hypothesis, membrane-tethered β-catenin coimmunoprecipitates with APC and relocalizes APC to the membrane in cells. Similar results are observed with ectopic plakoglobin, casting doubt on a normal role for plakoglobin in axis specification and indicating that ectopic proteins that interact with APC can artifactually elevate the level of endogenous β-catenin, likely by interfering with its degradation. These results highlight the difficulty in interpreting the activity of an ectopic protein when it is assayed in a background containing the endogenous protein. We next investigated whether the ability of β-catenin to interact with potential protein partners in the cell may normally be regulated by phosphorylation. Compared with nonphosphorylated β-catenin, β-catenin phosphorylated by glycogen synthase kinase-3 preferentially associates with microsomal fractions expressing the cytoplasmic region of N-cadherin. These results suggest that protein–protein interactions of β-catenin can be influenced by its state of phosphorylation, in addition to prior evidence that this phosphorylation modulates the stability of β-catenin.