Consumption of alcohol by pregnant women can cause fetal alcohol spectrum defects (FASD), a congenital disease, which is characterized by an array of developmental defects that include neurological, craniofacial, cardiac, and limb malformations, as well as generalized growth retardation. FASD remains a significant clinical challenge and an important social problem. Although there has been great progress in delineating the mechanisms contributing to alcohol-induced birth defects, gaps in our knowledge still remain; for instance, why does alcohol preferentially induce a spectrum of defects in specific organs and why is the spectrum of defects reproducible and predictable. In this study, we show that exposure of zebrafish embryos to low levels of alcohol during gastrulation blocks covalent modification of Sonic hedgehog by cholesterol. This leads to impaired Hh signal transduction and results in a dose-dependent spectrum of permanent developmental defects that closely resemble FASD. Furthermore, supplementing alcohol-exposed embryos with cholesterol rescues the loss of Shh signal transduction, and prevents embryos from developing FASD-like morphologic defects. Overall, we have shown that a simple post-translational modification defect in a key morphogen may contribute to an environmentally induced complex congenital syndrome. This insight into FASD pathogenesis may suggest novel strategies for preventing these common congenital defects.